Question:  In anticipation of legislative changes, I was advised to engage in various gifting and other tax planning transactions at the end of 2012 which I did not do. Now that the law has essentially remained the same, is there any immediacy to embark on such planning?

Answer:  The end of 2012 caused many individuals to engage in various estate and other tax planning transactions for fear that a reduction in the Federal transfer tax exemption and other tax changes would significantly inhibit future planning.  As it stood, Congress did not reduce the estate tax exemption which currently stands at $5,250,000 and many other anticipated changes were not adopted.  While many individuals who did not pursue strategic tax planning prior to 2013 may believe there is no longer any urgency, prospective legislative changes could eliminate some of the frequently-utilized tax planning techniques.

Some of the potential statutory changes are as follows:

1. Estate Tax Rate and Exemption Changes. The government has proposed increasing the Federal estate tax rate from 40% to 45%. Also on the horizon is a potential decrease in the Federal estate tax exemption from the current $5,250,000 to $3,500,000. Given the possibility that the government will not retroactively penalize taxpayers who make gifts using today’s potentially higher transfer tax exemption, now would seem to be the time to engage in gift tax planning.

2. Valuation Discounts. Taxpayers who make gifts of business interests (e.g. shares of stock in a corporation, ownership interests in a limited liability company, partnership interests, etc.) often claim valuation discounts for the interests transferred, particularly where the business interests are not publicly traded and/or represent a minority interest. For example, one might think that a gift of a 40% shareholder interest in a corporation with a market value of $5,000,000 would be valued at $2,000,000. In fact, if the corporation’s shares are not publicly traded and/or the gifted shares constitute a minority interest, the gift might be valued with a discount ranging anywhere from 20% to 50%. In this example, the donor could gift the corporate shares which have an intrinsic value of $2,000,000 yet report a lesser gift for gift tax purposes ($1,400,000 with a 30% valuation discount). The government has proposed eliminating valuation discounts for transfers made to related family members. Individuals who wish to utilize valuation discounts to transfer business interests to children and other younger generation family members may have a limited window of time to do so.

3. Dynasty Trusts. Many high net worth individuals contribute assets to trusts for children and other family members and permit the trusts to continue indefinitely. So-called “dynasty trusts” are often created without incurring estate or gift tax and continue for successive generations without transfer taxes being imposed. Not only the original trust corpus but future appreciation in the trust assets may permanently escape Federal transfer taxes. The government has proposed limiting the terms of dynasty trusts.

4. Retirement Plan Contributions. Taxpayers currently have considerable flexibility in deducting contributions to retirement accounts such as 401(k) plans, IRAs, pension plans and profit sharing plans. Continuous plan funding coupled with tax-deferred growth can yield sizable accumulations. A taxpayer need only comply with statutory minimum distribution retirements that mandate that annual withdrawals be taken once the taxpayer attains age 70 ½. While Federal law limits the amounts which can be contributed to such plans, there is no cap on the accumulation of funds in retirement accounts. The government has proposed limiting the opportunity of each taxpayer to continue to fund plans once the aggregate value of the taxpayer’s retirement accounts approximates $3,400,000.

Other government proposals which many catch many high net worth individuals off guard include accelerating distributions from retirement plans, eliminating opportunities to sell assets to certain trusts without incurring income taxes and limiting the opportunity to place assets in certain so-called “grantor retained annuity trusts” which provide family tax savings opportunities. Now more than ever is the time for high net worth individuals who have not engaged in strategic planning to take advantage of opportunities which may not be available for much longer.  There is a good possibility that the next round of tax legislation will thwart many of these opportunities.

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter, you may contact Bruce at (312) 648-2300 or send an e-mail to [email protected].

CIRCULAR 230 Notice:  In order to comply with requirements imposed by the Internal Revenue Service, we wish to advise you that (a) any U.S. federal tax advice contained in this communication is not intended and cannot be used for the purpose of avoiding tax-related penalties, and (b) no one, without prior written consent, may use any advice contained in this transmission in promoting, marketing, or recommending any entity, investment plan, or arrangement to another taxpayer.