Smart Year-End Moves for Different Levels of Wealth

Estate and gift taxes may suddenly become an issue for millions of Americans in 2013.

Estate and gift tax exemptions will fall to $1 million for the first time since 2003 if Congress doesn’t act, leaving many people who have no estate or gift tax liability today to face a considerable liability next year.

The new certainty is uncertainty, so don’t wait for Congress to act. Make your estate-tax planning moves now.

People with up to a few million dollars should be wary if a planner proposes an overly complex plan. If you’re in this group, keep it simple.

Well off people often can afford to give enough wealth to family members to reduce potential federal (and state) estate taxes. A financial planner can help you decide how much is affordable.

Everyone can give any individual up to $13,000 a year without using up his or her lifetime gift exemption. For instance, a married couple with four grandchildren could give them a total of $104,000 a year.

With 529 college savings plans, you can accelerate five years of giving into one. A single person can give up to $65,000 per 529 beneficiary per year, and a couple can give $130,000.

Another easy way to reduce your estate without eating into your gift exemption amount is to pay for someone else’s education or medical expenses by reimbursing the institution directly.

Don’t neglect the basics. Married couples worth significantly more than $1 million should have a credit-shelter trust provision in their wills so that each spouse’s $1 million estate tax exemption will be fully preserved.

The current law provides portability, which allows a spouse’s unused exemption to transfer to the survivor at the first death automatically, but that applies only to 2011 and 2012 so far.

Sophisticated planning for the very wealthy

People worth more than about $10 million face different challenges and opportunities.

The current exemption amount for both estate and gift taxes is $5.12 million for an individual and $10.24 million for a married couple. Since that exemption may be heading back down to $1 million, the ultra-wealthy have a brief window of opportunity to make big tax-exempt gifts this year. If you can afford it, give it away now. There’s little downside. Making a gift sooner also will allow more time for assets to grow outside of the donor’s estate.

But the ultra-wealthy shouldn’t just plop down millions in cash for their future heirs. Instead, it makes sense to use one or more sophisticated estate tax-reduction techniques.

One strategy is to create a trust for your beneficiaries. Everything you give to an irrevocable trust is removed from your estate. With an intentionally defective grantor trust, there’s an additional benefit: The grantor pays the trust’s taxes, which allows the trust to grow quicker.

Consider a trust funded with $5 million that generates $250,000 of annual income. The donor would effectively transfer an additional $875,000 to the trust, tax-free, over the next 10 years by paying its taxes, assuming a 35% tax rate on the trust.

Additionally, individuals can often transfer minority interests in private companies at a discount to the company’s total value. These discounts require a professional valuation study and vary greatly, but can often exceed 30%. With a 30% discount, the donor could transfer more than $7.3 million transfer tax-free, instead of $5.12 million. Investors in private equity funds may also be able to transfer their interests at discounts to the fund’s stated value.

With interest rates at historic lows, intra-family loans represent another great opportunity to transfer additional wealth. The older generation can make a loan to the younger generation without gift consequences, so long as they charge interest at the minimum applicable federal rate (AFR), currently a miniscule 0.89% for loans that mature in three to nine years. Any appreciation in excess of the AFR rate will be effectively transferred to the younger generation.

Those who are charitably inclined can take advantage of the low-interest rate environment through a Charitable Lead Annuity Trust. This type of trust makes annual payments to a charity; at the end of its term, any remaining assets pass to the non-charitable beneficiaries, such as children and relatives.

Whether the estate and gift tax is a new challenge for you, or an ongoing part of your financial planning, it’s important to create a plan that works for you no matter what. Build in flexibility to deal with any future changes Congress may throw your way.

Benjamin C. Sullivan, CFP, is a financial planner and portfolio manager with Palisades Hudson Financial Group, in Scarsdale, N.Y. Palisades Hudson is a fee-only financial planning firm and investment advisor with $1 billion under management. Branch offices are in Atlanta, Ga., Portland, Ore., and Fort Lauderdale, Fla. He can be reached at ben@palisadeshudson.com.