The law signed by President Obama on December 17, 2010, extending the Bush income tax cuts, came with a surprise estate and gift tax benefit for high net worth individuals – a $5 million gift and death tax exemption. Thus, individuals can protect $5 million from estate tax upon death (or $10 million for a married couple).
For most of us, the ability to protect $5 million from estate tax is sufficient. However, many individuals have assets that exceed that amount. Moreover, the law is only for two years, leaving us with the same uncertainty in 2012 that we faced in 2010. Further, many states, such as Maryland, only allow a $1 million exemption (fortunately Virginia currently has no estate tax).
Thus, rather than wait until death, many individuals should take advantage of the extraordinary wealth transfer opportunities available due to tax-free gifting of up to $5 million of assets. Most of us in the estate tax world were surprised when the estate tax exemption was increased to $5 million. However, we were shocked when the law allowed for gifts of up to $5 million. While increasing the gift exemption to $5 million for two years, Congress left untouched for now gifting strategies, such as GRATS and intra-family discounting of assets.
The bottom line? High net worth individuals should strike while the estate and gifting law is in their favor. There are a number of strategies available, many of which I have written about in the past, such as GRATS and gift/sale techniques to intentionally defective trusts.
Certain strategies take advantage of gifting and the advantage of life insurance to protect and leverage the assets for the family and future generations. The common denominator in these strategies are 1) an Irrevocable Trust; 2) transferring assets into the Trust; and 3) a portion of the transferred assets, or a portion of the income generated from the transferred assets, is used to purchase a life insurance product. Because an Irrevocable Trust is used, the assets are protected for the children and future generations in perpetuity from estate tax and also from creditors and failed marriages. The transfer to the Irrevocable Trust constitutes a completed gift, and the donor takes advantage of the $5 million gift exemption. Thus, when the insurance is purchased inside the Trust, there are no further gift tax consequences. The advantages of purchasing life insurance by the Trust include diversifying and leveraging the Trust assets; providing liquidity upon death to pay death taxes; and providing tax free cash accumulations inside the policy which could be tapped by the Trust beneficiaries during the insured’s life.
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