Parents, if your children have unexpectedly started cleaning their rooms, adhering to curfews, and making you breakfast in bed, there’s good reason to be suspicious. Kids, start doing those things immediately and casually mention that you saw something on the Web about an upcoming change to the gift tax exemption. This holiday season could result in a lot more value changing hands than usual, which means we can expect a lot more sucking up in the coming months.
All kidding aside, New Year’s marks an important date for the way wealth in the United States is passed down from generation to generation. This is when the federal lifetime gift-tax exemption will revert back from the roughly $5 million threshold now in place thanks to the Tax Relief Act of 2010 to the standard $1 million. In other words, through December 31, 2012 you can give another individual (presumably a loved one) up to $5.12 million without it being taxed, but come New Year’s, amounts over $1 million may be taxed at rates upwards of 50%.
A wealthy individual can therefore pass down a lot more of their money to their children and a lot less to the United States government simply by accelerating their timetable for giving. This is especially true since certain assets worth roughly $5 million could grow exponentially between now and the time you would ordinarily pass them down.
It’s no surprise that accountants and estate attorneys are already seeing a significant uptick in business from consumers looking to take advantage of this window to save millions and are expecting a chaotic last quarter of the year. Likewise, it’s understandable if consumers aren’t quite sure how to react. What if your children aren’t old enough to handle the financial responsibility of a potentially multi-million-dollar gift? What if Congress extends the exemption? What’s the best way to facilitate the exchange of assets anyway? These are all salient questions that must be answered by wealthy Americans in the near future, especially since the logjam of business for tax professionals toward the end of the year will make last-minute maneuvering difficult.
Well, you can’t bank on Congress moving to extend the exemption in light of the election, the healthcare issue, and the recent lack of political efficiency, so you must proceed under the impression that it will disappear come the end of the year. The safest way to pass down valuable assets is to establish a trust. This gives a third-party, typically a financial advisor or other investment professional, stewardship of the assets (e.g. the deed to a house, title to a car, or stock portfolio) until the beneficiary reaches a certain age. It will also help protect the money in the event that the beneficiary gets sued, becomes heavily indebted, or gets a divorce.
Since it’s likely that anyone establishing a trust to beat the upcoming gift-tax-exemption deadline will be doing so ahead of schedule, you might be nervous about forgoing your ability to use some of the money you pass down should you need it in the coming years. There are actually a few ways you can maintain a modicum of control over your money while it’s in a trust. In some states, you can establish a self-settled trust, which you will be an “eligible” beneficiary of, rather than an “entitled” beneficiary. This would allow you to request funds from the trustee. In addition, you could designate your spouse as a “discretionary” beneficiary and establish that they get periodic pay outs.
Finally, if you are concerned about an unrelated financial professional handling your money for years on end, appoint someone close to be a trust protector. This will give them the managing control over the trust and will help check the power of the primary trustee.
At the end of the day, while making these kinds of financial decisions might seem both daunting and premature, taking advantage of the current gift-tax exemption is a potentially multi-million-dollar proposition, so you owe it to your loved ones to at least consult an estate attorney and look into the efficacy of doing so.