Top Ten Year-End Estate Planning Tips

1. Use It or Lose It — Use Your Annual Exclusion

The annual gift tax exclusion amount is the amount a person can gift to any number of recipients without a gift tax consequence. This amount is $12,000 ($24,000 for gifts from husband and wife; i.e., split gifts) for 2008. The annual exclusion amount will increase to $13,000 ($26,000 for split gifts) in 2009.

When determining how much annual exclusion you have available to give to a specific person, count the beneficiary’s share of insurance premiums contributed by you to any Insurance/Irrevocable Trust or by other gift but don’t count any gifts for education tuition or medical expenses that you paid directly to a school or medical provider, such as birthday or holiday gifts.

The annual exclusion does not carry over to future years.  Therefore, you either use it this year, or you lose your chance to make this tax free gifts.

2. Utilize Your Gift Tax Exemption

Each person has a lifetime gift tax exclusion of $1,000,000 (this amount is not likely to increase like the estate tax exemption), in addition to the annual exclusion gifts (explained above) and direct payments of medical or tuition expenses.  Thus, an individual can make gifts in excess of the annual gift tax exclusion amounts (discussed above) of up to $1,000,000 during his or her lifetime, before having to pay any gift tax (though a gift tax return has to be filed).

Before you use your lifetime gift tax exclusion, you should consult with a tax advisor to make sure that you use your lifetime gift tax exclusion in the most tax advantageous way.

Gifts between spouses are not subject to gift tax as long as the receiving spouse is a U.S. citizen.

Gifts to a non-citizen spouse are not eligible for a marital deduction or the gift tax exemption but are eligible for a special annual exclusion amount. This non-citizen spouse annual gift exclusion is $133,000 for 2009 and will continue to be indexed for inflation in future years.

Any gift to anyone, including your spouse, can be made outright, to a 529 Plan, to UTMA accounts or to irrevocable trusts.

3. Pay Tuition and Medical Expenses

Payments for tuition and medical expenses are not considered taxable gifts and are not included in annual exclusion limits or in the $1,000,000 lifetime exclusion. A donor, for example, can pay the tuition expenses for a donee at any educational level without any gift tax consequence. In order to be exempt from the gift tax, payments must be made directly to the educational institution or medical professional.  If you have a grandchild or child who is definitely going to a specific college or educational institution, please inquiry with your tax advisor how you can “prepay” for the tuition, without it being considered a gift.

4. Preserve Your Estate Tax Exemption

The estate tax exclusion is currently $2,000,000. In 2009, however, the combined estate tax exclusion for each individual will increase from $2,000,000 to $3,500,000 (the “exclusion amount”), unless Congress changes the law. In light of the increase in the exclusion amount, a husband and wife will be able to protect up to $7,000,000 (in 2009) from the federal estate tax with proper estate planning.

A proper estate plan, at a minimum, requires the first spouse to die to title assets valued at $3,500,000 in his or her own name (or in their revocable trust) for which the surviving spouse is not the designated beneficiary, and a will or revocable trust that carves out the exclusion amount into a trust for the surviving spouse.

It is important to note, while the estate tax exemption is scheduled to increase to $3,500,000 in 2009, followed by the repeal of the estate tax for one year in 2010, in 2011 and thereafter, the estate tax applicable exclusion amount will decrease to $1,000,000 (adjusted for inflation). Additionally, the top current federal estate and generation-skipping tax rate is 45% and, unless the law is changed, will stay at that rate through 2009. In 2010, the federal estate and generation-skipping tax rate is scheduled to fall to 0%, and then revert to a top rate of 55% in 2011.

The top gift tax rate is also currently 45%. However, even after the scheduled repeal of the estate tax in 2010, certain gifts will remain subject to tax at the top individual income tax rate, which is currently 35%.

Also, some states, like Maryland and DC, imposed their own estate tax, so while you may shelter $2,000,000 or $3,500.000 for Federal estate tax purpose, there may still be state estate tax.

5. Fund a 529 Plan

Section 529 of the Internal Revenue Code affords a taxpayer with an opportunity to establish a special account for the purpose of paying higher education expenses. Investments in a 529 Plan accumulate income tax free and distributions used for qualified education expenses are not subject to federal income tax. One common technique is “frontloading” gifts to a 529 education savings plan. You can make five years’ worth of annual exclusion gifts, or $60,000, to a 529 plan in 2008 for the benefit of any one person, but annual exclusion gifting to that person over the next four years will be reduced by $12,000 per year. This is especially effective when markets are depressed.

6. Create and Fund a Grantor Retained Annuity Trust

A Grantor Retained Annuity Trust (”GRAT”) is an irrevocable trust into which you transfer assets into the trust and retain the right to receive annual payments of a fixed dollar amount for a specified term of years. At the end of the trust term, the remaining trust assets pass to family members or a trust for their benefit.

The IRS assumes that a GRAT will grow at a rate equal to the 7520 rate at the time the trust is established (3.4% for December). Growth which exceeds the assumed rate passes to trust beneficiaries free of gift and estate tax. The lower the hurdle or interest rate, the larger the potential gift. GRATs are a preferred wealth transfer option in a low interest rate environment because it is relatively easier to outperform the hurdle rate than in a high interest rate environment. Like many estate planning techniques, GRATs can be very effective when assets values and markets are depressed.

GRATs are also “grantor trusts” which means that the grantor (creator of the trust) is taxed on all of the income. Payment of these income taxes is effectively a tax-free gift to the trust beneficiaries since the trust assets can grow without reduction for income tax payments.

In short, using a GRAT, a client can transfer assets to a trust on a gift-tax-free basis, receive the assets back over a period of years with a rate of return and any excess growth is outside the client’s estate.

7. Create and Fund a QPRT

Real estate values are presently low and many clients are considering transferring their vacation properties or personal homes to their descendants. Under current conditions, individuals have an opportunity to make a discounted gift using a Qualified Personal Residence Trust (”QPRT”).

If structured properly, the QPRT will freeze the value of the taxpayer’s residence at the time they create the trust and transfer the residence thereby resulting in significant estate tax savings. QPRTs are often considered most effective when interest rates are high; however, while interest rates today are currently very low, the low interest rate may be offset by current low housing prices.

After the gift, the donor can continue to live in the residence for the term of the trust, and potentially longer by renting the residence.

8. Intra-family Lending

Low interest rate environments are an excellent time for a legally documented intra-family loan. One means of wealth shifting to the next generation is through the use of loans. Clients can set up an irrevocable trust for the benefit of their beneficiaries and loan the trust money to make investments. Using the Internal Revenue Service (IRS) published rates, which are required to be used to avoid income and gift taxes, the client can lend money to the trust with extremely low interest rates. This creates fantastic opportunities to shift growth investments outside the taxable estate and into a trust for the beneficiaries of the client at no cost. So long as the investments beat the interest rate charged, the beneficiaries win and the client has reduced estate taxes.

Also, since loans are not gifts, there is no need to allocate any estate tax exemption or generation skipping tax exemption. The assets in the trust can avoid estate taxes for hundreds of year!  Many clients already have loans outstanding to their children or to trusts. In this low interest environment, these notes may be renegotiated at a lower rate to reduce the debt service cost and to provide greater growth outside the estate. The notes can be set up with varying due dates and principal amounts and increase the estate’s tax free growth.

9. Freeze Transaction

An effective wealth transfer technique involves a freeze transaction whereby future growth in investments are sold to trusts which benefit a spouse and/or descendants. An example would be a sale of an ownership interest in a income producing real estate or a success family business to a trust for children in exchange for a long-term low interest promissory note or a lifetime stream of payments.

If a client owns a 50% tenant in common interest in a commercial office building, appraised at $2,000,000 in assets, then the 50% tenant in common interest, representing $1,000,000 in pro rata value, might be sold to the trust for a $700,000 promissory note, taking into account a 30% valuation discount. Under this transaction, if the commercial office building increases in value, the growth inures to the trust, which owes back only $700,000 plus interest to the client. Consequently, this immediately moves $300,000 worth of wealth from the client’s taxable estate, and if the $1,000,000 interest int eh commercial office building increases, the difference between the growth in value and $700,000 plus interest has been shifted to the trust for the children.

10. IRA Charitable Rollover

Renewed federal legislation permits individuals 70 1/2 and over to again make a tax-neutral distribution of up to $100,000 from their Individual Retirement Account (IRA) in 2008 and 2009. The charitable transfer may be earmarked for a specific use within a charity but it may not be designated for a donor advised philanthropic fund, supporting foundation, charitable remainder trust or charitable gift annuity. A transfer from an IRA, under this law, is excluded from federal income tax, and qualifies toward the mandatory required minimum distribution but does not qualify for a charitable deduction.

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