Is it time to give away the farm?

By Ron Caron

The Daily Record Newswire

Since the Congressional Super Committee has failed to live up to its moniker, where does it leave the tax planning community? Well, the short answer is we still do not know.

Tax policy is an interesting blend of economics and politics. It is often difficult to know where one ends and the other begins. The lack of results from the so-called Super Committee is symptomatic of the toxic political environment in D.C. Against this backdrop, let's look at the federal gift tax and the possible planning opportunities under the "Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010" (TRA 2010).

In TRA 2010, each taxpayer is provided an exemption of $5 million to be applied against federal gift tax. This means that you, yes you, can make gifts totaling $5 million during your lifetime (presuming you have not made any prior taxable gifts) without fear of Uncle Sam taking a slice. If you are married (or otherwise in a committed relationship) your spouse (or your partner) can also make $5 million worth of gifts during his or her lifetime. Therefore, a couple can transfer up to $10 million during their lifetimes without federal gift tax. This shield against federal gift tax is even larger when you take into account the annual gift tax exclusion, currently $13,000 per year, which can be utilized on a yearly basis over and above the lifetime exemption.

So what will you do with your $5 million exemption (presuming you have a spare $5 million to spread around)? Who will benefit from your generosity? Is now the time to do it? Is it time to give away the farm?

Well, the short answer is a definite maybe and, to complicate things, the clock is ticking. This is because TRA 2010 is set to expire on January 01, 2013. TRA 2010 was a short-term fix to the expiring tax legislation known as "The Economic Growth and Tax Relief Reconciliation Act of 2001" (EGTRRA 2001). TRA 2010 essentially extended many of the tax provisions of EGTRRA 2001; however, with regard to federal gift tax, TRA 2010 was a significant tax cut. The federal gift tax lifetime exemption was actually increased five-fold from $1 million, under EGTRRA 2001, to $5 million under TRA 2010. However, if Congress fails to act (once deemed unlikely, but now more probable based on their recent track record), the gift tax lifetime exemption will drop back to $1 million and the gift tax rate will increase from the current 35 percent to 55 percent. In short, we will go back to the federal tax law that was in effect prior to EGTRRA 2001 due to the sunset provisions of TRA 2010.

Therefore, there may be no better time to make those extra large gifts for the holidays. This is an unprecedented opportunity to effect large transfers of wealth without incurring any federal gift tax. When you factor in the depressed values of real estate, this is a supercharged opportunity, as you are getting a discount on your gift. For example, if we assume a 30 percent drop in the value of real estate (from peak values in 2006), then you could transfer roughly $7.14 million in value ($5 million in today's money) free from federal gift tax. Coordinate your lifetime exemption with that of your spouse or partner and you can move $14.28 million of value for a total credit of $10 million. As real estate starts to appreciate, following the gift, the increased value will go to the gift recipient.

Pretty simple, right? Not so fast. If Congress follows the lead of its Super Committee and fails to find common ground on new tax legislation, come January 1, 2013, the exemption for federal estate tax, like the exemption for federal gift tax, will drop to $1 million from the $5 million exemption levels. Because the federal estate tax calculation takes into account the lifetime taxable gifts of the decedent taxpayer, there is the possibility that, due to the reduced federal estate tax exemption, a decedent's estate could incur a larger estate tax burden if the decedent completed lifetime gifts in excess of the decedent's applicable federal estate tax exemption in the year of his or her death. This is known as the "claw back". For example, if the taxpayer made $5 million of gifts prior to the end of 2012 and then dies when the federal estate tax exemption is $1 million, it is possible that the IRS might try to "claw back" the $4 million difference in the estate tax assessment against the taxpayer's estate.

Not surprisingly, there are differing opinions in the estate-planning world as to whether the "claw back" is likely. Once again, Congress, with TRA 2010, created more questions than answers, especially due to the law's short-term duration and novel applications. Because my time machine is in the shop, I cannot be certain whether the "claw back" will be later used by the IRS. While I believe that it would be unfair to take back a beneficial tax provision (lifetime tax exemptions have historically gone one direction, up), anything is possible inside the beltway as the nation's leaders deal with our national debt issues. Regardless, the potential of "claw back" is a consideration that must be made in the risk calculation as to whether to take advantage of this exceptional opportunity.

Democracy means that no one person gets everything he or she wants. Our experiment in self-government requires compromise. When Democrats and Republicans play the zero-sum game, we all lose. The debt issues facing our nation cannot be solved by only spending cuts or only tax increases. A balance of the two is the only rational way to address the debt. Here's to hoping that the New Year will bring with it resolutions from our leaders to put aside petty differences and myopic agendas and do what is best for our nation. In the meantime, be cautious about your tax planning opportunities and always consult your tax professional before making gifts of any amount.

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Ronald G. Caron, Jr., J.D./LL.M, is principal at RGC Tax & Estate Solutions, PLLC of Boise

Published: Tue, Dec 13, 2011

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