The Benefits of Gifting and Other Estate Planning in Tough Economic Times

The term “market tsunami” has reverberated in the media these days. While all of us are legitimately concerned about our 401(k) plans, investment accounts and other retirement benefits, the current economic climate presents an opportune time to review your Wills or other estate planning documents and consider gifting to your heirs. Gifting now, whether with real estate, closely-held stock, marketable securities or other assets, likely will be at a low cost and allow future appreciation to be passed down to heirs with minimal or no gift tax consequences.

The gift tax laws currently provide that an individual can pass up to $12,000 of assets to any donee free of Federal gift tax. This amount, referred to as the “annual exclusion amount,” increases to $13,000 on January 1, 2009. If a husband and wife agree to make the gift jointly, this limit is $24,000 per donee (or $26,000 as of January 1, 2009). For gifts exceeding the annual exclusion amount, an individual can gift up to $1,000,000 during life without paying any Federal gift tax to the IRS. At the state level, New Jersey does not impose a gift tax. While we are faced with tough economic times, individuals who can afford to give away assets – and live with that reality – should seriously consider making gifts of stock or other assets to their intended heirs. Take a simple example – if a stock is currently worth $5.00 per share, a parent can gift 2000 shares to a child and this gift will qualify as an annual exclusion gift. The parent will not have any gift tax reporting requirement and no gift tax implications. If the stock reaches $50.00 per share in 5 or 10 years, parent has gifted $100,000 to the child with no gift tax consequences. Combined with the ability to make annual exclusion gifts, an individual can pay for another person’s medical expenses or college tuition in any amount if you make payments directly to the medical service provider or educational institution.

Real estate also becomes an ideal asset to consider gifting at this time with property values at historically depressed levels. The amount of the gift will be the fair market value of the real estate at the date of the gift. In determining fair market value, discounts should apply if the real estate is owned as tenants-in-common with someone else or held in the form of an LLC or other type of business entity. This means you can transfer the real estate to your heirs at the currently depressed value and keep any future appreciation outside of your estate for estate tax purposes. For gift tax purposes, if you gift real estate today worth $500,000, you will utilize a portion of your $1 million lifetime gift exemption by making the gift but not pay any out-of-pocket gift tax to the IRS. If the real estate appreciates to $800,000 in several years, you have gifted this asset to your heirs at the depressed value and passed the $300,000 appreciation to your heirs gift-tax free. Certain gifting options also exist that allow you to retain the right to live in the residence while making a gift of the future remainder interest to your heirs based upon the value of the real estate today.

Certain sales of assets as part of one’s estate plan also can prove beneficial during tough economic times. One particular estate planning technique involves the sale of assets to an intentionally defective grantor trust, or “IDGT.” An IDGT is a trust under which the original creator, or grantor, is treated as the owner of the trust assets for income tax purposes, but not for gift or estate tax purposes. Any transactions, such as sales, between an IDGT and grantor are ignored for income tax purposes. This allows the grantor to loan money or sell property to an IDGT in exchange for a promissory note with no adverse income tax consequences. With historically low interest rates, this becomes very attractive. The interest rate charged on the note must be at or above the applicable Federal rate, or “AFR,” allowed by the IRS. Currently, the AFR for a 5-year note with interest payable annually is 2.85% compared to 4.13% only one year ago. Since an IDGT is treated as a grantor trust for income tax purposes, no gain or loss will be recognized on the sale of the grantor’s asset to the IDGT in exchange for the promissory note. Further, the grantor will not be taxed on the interest income paid on the note during the term of the note. Essentially, a sale to an IDGT freezes the value of an asset in a grantor’s estate at the sales price and allows the grantor to transfer assets with the potential for substantial appreciation out of his estate with favorable estate and gift tax results.

In addition to thinking about gifts to your heirs or the sale to an IDGT, it is critical to revisit your Wills in light of the current economic climate. Perhaps specific bequests of assets to certain family members are no longer realistic. For example, if your Will leaves the family business to the child actively participating in the business and leaves all your other assets to children who are not actively participating, and your original estate plan was to equalize this division of business and non-business assets as much as possible among your children, you need to consider whether this estate plan requires a tune-up given today’s decreased financial and real estate portfolios.

One further note – the Federal estate tax exemption increases to $3,500,000 per individual as of January 1, 2009 (the current exemption is $2,000,000). This increased Federal exemption will reduce the number of estates that will be required to pay Federal estate tax. Importantly, however, New Jersey’s threshold exemption is substantially lower because New Jersey imposes an estate tax on a decedent’s estate if the value of the estate exceeds $675,000. While certain deductions, like a marital deduction, apply to reduce or defer the amount of New Jersey estate tax, New Jersey has no plans to increase its $675,000 exemption. To consider some numbers, an estate valued between $675,000 and $2,000,000 will pay New Jersey estate tax of approximately $100,000. If the estate is $3,500,000 as of January 1, 2009, there will be no Federal estate tax but the New Jersey estate tax will be approximately $230,000. So while the increased Federal estate tax exemption may result in more estates exempt from the Federal estate tax, if you are a New Jersey resident, your New Jersey estate tax may increase. For New Jersey residents, this is another reason to consider gifting and other estate planning alternatives even in this era of the “market tsunami.”

Should you have any questions regarding your own situation, please contact Rita Danylchuk of our Trusts and Estates Group.