Lately, I've been hearing this question in various circles, from lawyers and laymen alike – was it a mistake for people to give big gifts in 2012? Now, there's a solid reason that they've been asking themselves this question. Last night, the Senate and House of Representatives approved the American Taxpayer Relief Act of 2012 in an effort to keep our country from going over a fiscal cliff.
As part of that deal, estate and gift tax exemptions — which were set to drop from $5.12 million to just over $1 million — are now preserved "permanently." That is, one of the chief motivators for people to make gifts in 2012 has turned out to be a false alarm.
Nothing like a lively Senate debate on important issues.
It's only natural that people are now asking if estate planners and tax attorneys jumped the gun by encouraging people to distribute large gifts before 2012 came to an end. Did the crystal ball malfunction? Was bad advice given as a result? In almost all cases, the answer to these questions is a resounding "No!" There are four primary reasons why the answer is no, and it's important that we discuss what someone considering making a gift should do with the new information that has come to light.
1. Estate, gift, and generation-skipping transfer tax rates will remain the same… until they change.
For what feels like the first time in forever, there finally appears to be some certainty (which should be taken with a grain of salt) in the transfer-tax regime. While the "applicable exclusion" (the amount exempt from estate and gift taxes) has been made permanent and been attached to reflect inflation rates, no one can predict if and when Congress will change its mind. A law is only in effect until it is changed or modified, and – as we're all painstakingly aware of – our legislators love tinkering with the tax code.
2. The "estate freeze" and the rule of 72.
When you make a lifetime gift, whether in a trust or outright, the gift is taxed at the fair market value of the time it is made. The result? Any increase in the value of the gift is not included in your estate, and it is not subject to additional gift and/or estate taxes.
You may have heard of the rule of 72. If not, here's how it works: take the rate of interest that you expect to earn on a particular asset over time. Divide that rate by 72. The number you end up with is (roughly) the amount of years it will take for the value of that investment to double. Let's say you expect to earn a steady 7.2% on $5.12 million. In 2012, you decided – with the right advice – that you could give those assets away and still live comfortably, so you make a gift in trust for future generations. In 2022, with no distributions, those assets will have doubled (7.2 /72 = 10 years). Assuming this was the first taxable gift you made during your life, you took full advantage of your lifetime exclusion from transfer tax, and now your heirs stand to inherit $10 million+ without paying any transfer tax. Not bad, right?
3. "Tax exclusive" vs. "tax inclusive."
Another major benefit to making gifts during your lifetime is that any transfer taxes paid more than three years prior to the date of death are excluded from the value of the estate. Even if you have used your applicable exclusion in 2012, you can still make gifts that your estate will benefit from going forward.
4. Asset protection
So, you made an irrevocable gift in 2012. Despite what you might be thinking, that's a good thing! If you had a decent estate-planning attorney, I'm sure that some layer of asset protection was included in your plan. First, the obvious; your creditors can't reach what you no longer have access to. If you finalized a gift, those assets are almost always out of reach for anyone who decides to sue you (but please speak to a qualified attorney to make sure this is the case for your circumstances).
Second, your beneficiaries should receive some level of protection; if you made lifetime gifts by utilizing a trust, there's a good chance that asset protection for your beneficiaries was included in the plan. If they get sued, they won't be at risk of losing the proceeds of your generosity.
I know I said there were four reasons why it wasn't bad advice to make sizable gifts in 2012, but I want to add a fifth. Tax rates DID go up. Paying 5% less in gift tax is never a bad thing. But here's the thing – I believe that at the end of the day, the goal of estate planning isn't — or shouldn't be — about minimizing taxes. That being said, any competent estate planner will consider possible tax implications when designing and executing a plan. But that's not really what you are after, is it? People generally don't decide to do an estate plan because they want to keep their hard-earned money out of the hands of an incompetent government.
Now we have to answer the question, "Why do people plan what happens when they pass on?" The answer isn't particularly radical. People plan for peace of mind. They plan to rid their world of potential uncertainties. They plan to provide for their families. They plan so that they can decide what their money should be spent on, whether or not they are still around to express and control their wishes. It's about family, it's about love, and it's about what you care about.
Getting hung up on the IRS estate and gift tax rates can distract you from the most important things in life. So when you are thinking about making a gift to loved ones, or to a cause you care about, your concern isn't really taxes. There's a LOT more to it than tax planning. It comes down to successfully doing what you want with your money, and doing it as effectively as possible. It's not too late to plan, until it is. Make the right decisions and find your peace of mind.