2010 Year-End Planning Opportunities

November 29, 2010 Advisory

Now that we feel reasonably confident that Congress will not reinstate the estate and generation-skipping transfer tax laws retroactively, we believe that 2010 affords unique estate planning opportunities that may not be available in 2011.

For 2010 the federal estate and generation-skipping transfer (GST) taxes were repealed in their entirety. If Congress does not extend the estate and GST tax provisions of the Bush-era tax cuts, on January 1, 2011 these taxes will revert to the provisions in effect in 2001, with a 55% rate and a $1,000,000 exemption[1]. The federal gift tax was not repealed. Instead, for 2010 the federal gift tax rate decreased to 35% and the exemption remained at $1,000,000. Without legislative action, the gift tax rate will rise back to 55% in January.

Taxable Gifts
The gift tax rate in 2010 is 35% and it is expected to rise to 55% in 2011. If you exhausted your lifetime gift tax exemption of $1,000,000, paying tax on gifts can be more advantageous than paying estate tax on the same property. This is because the gift tax is imposed on a "tax exclusive" basis, while the estate tax is imposed on a "tax inclusive" basis. Put simply, the funds used to pay the estate tax are taxed in a decedent's gross estate, but the funds used to pay the gift tax are not included in the tax liability. For example, compare an individual who makes a lifetime taxable gift of $1,000,000 in 2010 versus an individual who makes a bequest at death of $1,000,000 in 2011. The family of the person making the taxable gift in 2010 can save over $872,000 in taxes[2] as illustrated in the chart below:

Lifetime Gift of $1,000,000 in 2010

Bequest at Death of $1,000,000 in 2011

Tax Rate



Gift or Estate Tax



Total funds needed to transfer a net $1,000,000 to the recipient



The analysis above assumes that Congress will not retroactively repeal the 35% gift tax rate or replace it with a higher rate. While retroactive repeal of the 35% rate seems a remote possibility, clients considering making taxable gifts in 2010 should consult with their Wiggin and Dana attorney about methods for minimizing the risks associated with a possible retroactive repeal.

Gifts to Grandchildren
Ordinarily a gift to a grandchild results not only in a gift tax but also in a separate GST tax. As noted above, however, for 2010 only the GST tax is repealed. Accordingly, a gift to a grandchild should magnify the benefits of making a taxable gift in 2010 because the gifted property is removed from the transfer tax system for two generations rather than only one. However, because of certain technical provisions of the law, it appears that only gifts made outright to grandchildren will achieve the additional GST tax savings. A gift in trust, or even a gift to an UGMA or UTMA account for a grandchild, may not safely avoid GST tax in future years. Clients considering gifts to grandchildren, and especially gifts to trusts, in 2010, should consult with their Wiggin and Dana attorney before making any such gift.

Trust Distributions
Distributions from trusts that are not exempt from GST tax may be made to "skip" persons (usually grandchildren or great-grandchildren of the individual who created the trust) in 2010 without the imposition of GST tax. This law is only in effect in 2010 and, come 2011, distributions to "skip" persons will incur a GST tax. If you are the trustee or the beneficiary of a trust that is not exempt from GST tax, the pros and cons of a distribution from the trust to a skip person or persons should be carefully considered before the end of this year.

A Grantor Retained Annuity Trust, or GRAT, has been a useful and reliable tool for removing significant wealth from an individual's estate at a low gift-tax cost. In a typical GRAT, you transfer property to a trust, receiving back an annuity payment for a fixed term. At the end of the term, the remaining trust property passes to your children or other family members gift tax free. The taxable gift is measured as the total value of the property placed in the trust minus the discounted present value of the retained annuity. The discounted present value of the retained annuity is calculated using the Applicable Federal Rate (AFR), as set monthly by the IRS.

Over the course of the past year, several proposals have been introduced in Congress that would significantly limit the availability of the GRAT technique. While the law has not yet changed, clients considering a GRAT should be aware of the possible legislative threat and may wish to act immediately to establish a GRAT before any change in the law. In addition, the December 2010 AFR is 1.8%, which is a historically low rate. If you are considering a GRAT, or if you have concerns about your existing GRAT, now is the time to act.

Intra-Family Loans
Loans among family members must carry a minimum interest rate to avoid being recast as gifts. The interest rate is set by the IRS and is 0.32% for a short-term loan (less than 3 years)[3]; far less than the rates charged for most commercial loans. Clients should consider loans to get principal into the hands of beneficiaries, who can invest the money and earn a rate of return which is higher than the interest rate charged on the loan. The interest rate differential represents an opportunity to create a tax free shifting of wealth to younger generation family members.

Talk to Us
It is impossible to predict precisely how Congress will address the expiring estate tax repeal. However, if Congress does not act and the laws scheduled to come into existence in 2011 apply to your estate, you may miss a planning opportunity. We recognize that this can be a challenging and even confusing time for you in thinking about your estate planning. Please don't hesitate to contact any of the lawyers in Wiggin and Dana's Private Client Services Department with questions about this Alert or any planning issue.

[1]The GST tax exemption in 2011 will actually be greater than $1,000,000, as the figure is adjusted for inflation. As of the printing of this Alert, the precise figure has not been released by the federal government.

[2]To achieve the full tax savings, the donor must live for more than 3 years after making the gift.

[3]Rate for loans made in December, 2010.