December 2, 2008

As 2009 approaches, we can look back on a year of unprecedented events that have left us cautious about how to plan for the future: a historic election, uncertainty about changes in the tax laws, financial upheaval that has brought low interest rates and fear of a long recession. While these issues can cause much angst, they also present planning opportunities. Now is the perfect time to conduct a review of your estate plan. You should carefully weigh your options to determine appropriate strategies with special consideration of the following:

  • Annual Exclusion Gifts
  • Tuition and Medical Gifts
  • Federal and State Estate Tax Exemptions and Rates
  • Lifetime Gift Exemption
  • Generation-Skipping Transfer Tax Exemption
  • Putting Your Exemptions to Use
  • Gifts in Trust
  • Charitable Distributions from IRAs
  • Prepare for Roth IRA Conversions

Annual Exclusion Gifts

One of the most powerful estate planning techniques is also one of the simplest. For 2008, individuals can make an unlimited number of gifts of up to $12,000 per recipient, per year. This amount will increase to $13,000 per recipient in 2009. Over a period of time this can result in substantial transfer tax savings (as both the gift itself and its income and growth are removed from the donor's estate), without paying gift tax or using any lifetime gift exemption (discussed below). Gifts made earlier in the year are generally more beneficial, as the income and appreciation inure to the benefit of the donee rather than the donor. However, if an annual exclusion gift is not made by the end of the year, that year's exclusions will be lost.

Tuition and Medical Gifts

Additional unlimited gifts can still be made by paying tuition costs directly to the school or medical expenses directly to the health care provider.

Federal and State Estate Tax Exemptions and Rates

The amount that an individual may pass free of federal estate taxes is currently $2 million, rising to $3.5 million in 2009. Current law allows an unlimited amount to pass estate tax free in 2010, and reduces the amount to $1 million in 2011. However, anticipated estate tax reform will likely fix the exemption at $3.5 million going forward. The federal government also imposes taxes at a flat 45% rate, which is not expected to change.

The federal government no longer shares the estate tax with the states. In a number of states, the federal and state estate tax exemptions have been decoupled (i.e., in 2009, even though the federal government will allow you to pass $3.5 million estate tax free, a state such as Illinois will impose its estate tax on taxable estates in excess of $2 million). If you have not reviewed your estate planning documents in the last few years, now is an important time to do so in order to incorporate more flexible and tax-advantageous formulas into your documents to better address such decoupling issues.

While Illinois may have an effective estate tax rate of approximately 8% (after factoring in the federal deduction for state taxes), other states such as Arizona, California, Florida and Nevada currently have no state estate tax.

Lifetime Gift Exemption

Although an individual can currently pass $2 million free of estate tax upon death, the same amount cannot be given away during lifetime without incurring a gift tax. The lifetime gift exemption remains at $1 million (in excess of the annual exclusion, tuition and medical gifts).

Generation-Skipping Transfer Tax Exemption

In order to ensure a death tax at each successive generational level, a generation-skipping transfer tax is imposed on transfers to grandchildren or more remote descendants at the top estate tax rate. However, the same amount that can pass free of estate tax ($2 million) can pass generation-skipping tax-free to grandchildren and more remote descendants.

Putting Your Exemptions to Use

The combination of the recent market declines (which present an opportunity to transfer assets to your descendants at substantially reduced, if any, tax cost), the low interest rates (creating opportunities to leverage tax savings), and the changes in the law allowing increased amounts to pass estate and gift tax-free at death and/or during lifetime make this an opportune time to revisit these issues. As everyone knows, the economy moves in cycles. Eventually (hopefully) values will increase again. When they do, the opportunity to reduce, or even eliminate, your transfer taxes on such favorable terms may be gone.

Assets with "temporarily" depressed values due to the current economic conditions, but whose values are expected to recover, would be good targets for a giving program. Based on the current applicable laws, the increase in value when the economy recovers and the appreciation thereon would pass to the donees gift tax-free. The lower current applicable federal interest rates also make gifting through a grantor retained annuity trust (GRAT), a charitable lead trust (CLT), intra-family loans, and the sale to grantor trust technique even more beneficial.

Gifts in Trust

Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns can usually be addressed by structuring the gifts in trust, which will allow you to determine how the assets will be used and when your descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage.

Charitable Distributions from IRAs

During 2006 and 2007, individuals age 70½ or older were allowed to donate up to $100,000 from their individual retirement accounts (IRAs) to qualified public charities (not including donor advised funds or private foundations) without including these distributions in taxable income, but qualifying toward the required minimum distributions for the year donated. (Prior to 2006, gifts from IRAs to charities were treated as taxable distributions to the donor, with the income tax on such not necessarily being offset entirely by the charitable deduction.) The $700 billion Emergency Economic Stabilization Act of 2008 renews for two more tax years (2008 and 2009) this favorable income tax treatment afforded to direct charitable gifts from IRAs.

Prepare for Roth IRA Conversions

Individuals who have not been able to contribute to a Roth IRA because of income limitations will have a prime opportunity starting in 2010, when anyone, regardless of income, will be allowed to convert their regular IRA to a Roth IRA. Planning for such a conversion should begin now. Individuals who are not currently eligible to make Roth contributions may want to consider contributing to a regular or nondeductible IRA so that these amounts can be converted to a Roth IRA in the future. Individuals who currently qualify for a Roth conversion, but have not done so, may be able to take advantage of the market decline by converting their regular IRA to a Roth IRA at a much lower tax cost than would have been possible when stock market values were high. Individuals who completed a Roth conversion earlier this year when the market was much higher should consider transferring the Roth IRA back to a traditional IRA. This "recharacterization" may enable a future conversion to a Roth IRA at a substantially reduced income tax cost. However, 2008 transactions being so recharacterized must be completed prior to the due date, including extensions, of the individual's 2008 income tax return.

For More Information

These and other federal and state laws can have significant financial consequences for you and your family. We recommend that you speak to your Much Shelist attorney or contact a member of our Wealth Transfer & Succession Planning practice group to determine appropriate strategies that meet your objectives and address your circumstances.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.