2012 Mega Giftingby Frank Heinisch, Christin Lovegrove on 10/16/12
Should the $5,120,000 gift tax exclusion for 2012 be utilized by making a mega-gift before it expires? In 1976, Congress adopted a unified credit approach to federal estate and gift tax computations. The basic premise is that a taxable gift that is included on a Form 709 Gift Tax Return must be included on line two of the Form 706 Federal Estate Tax return.
In other words the previously taxable gifts must be added to the estate value as of date of death to compute the federal estate tax which is reduced by the unified credit to determine the balance of federal estate tax due nine months after death. A gift in excess of the annual gift tax exclusion in a calendar year ($13,000 per donee in 2012), is a taxable gift.
Over the years since 1976 the approach of combining the previous taxable gifts with the date of death value of the estate has not changed. The amount of the unified credit has been increased several times. Now the federal estate tax is equivalent to the current unified credit of $5,120,000.
Table of Unified Credits (Recalculated at Current Rates) [IRS Pub 950]Period Recalculated Unified Credit
1977 (Quarters 1 and 2) $6,000
1977 (Quarters 3 and 4) $30,000
1987 through 1997 $190,800
2000 and 2001 $217,050
2002 through 2010 $330,800
A unified credit is applied to the gift tax return and generation-skipping tax return in computing the balance of the tax due. Currently the gift tax unified credit and the generation-skipping tax exemption is the same as federal estate tax unified credit. Since 1976 the taxable gifts and generation-skipping taxes have often varied from the federal estate tax unified credit. In 2013, the gift tax and estate tax unified credit equivalent will be $1 million and generation-skipping exemption will be approximately $1.4 million ($1.0 million, indexed from 1997).
If a taxable gift is made, the federal estate tax return currently includes the previous taxable gift on line two of the Form 706 (Estate Tax Return). The advantage to making a taxable gift is to eliminate the appreciation of the value of the gifted item from the federal estate tax return as of date of death as well as removing the income earned by such gifted items.
The disadvantage of making a taxable gift is losing the step up in basis of assets included in a federal estate tax return. If an asset is gifted with a low tax basis [often the cost of the asset], there will be no step up in basis upon death. When that gifted asset is sold, the donee will pay capital gains tax on the difference between the sale price and the donor's basis. Gifted assets may be subject to both an income tax on the capital gains when the asset is sold (plus federal estate tax on the value of the asset as of date of death).
This year, federal capital gains are 15% and a Nebraska maximum rate of 7%, totals 22% in capital gains tax. Next year the federal capital gain rate is expected to be 20% and 7% Nebraska, totaling 27%. This year, the federal estate tax rate is 35% with a $5.12 million unified credit equivalent and under current law, next year the federal estate tax rate will be 55% with a one million-dollar unified credit equivalent.
If an estate is under $5.12 million, and property with a low basis is likely to be gifted in 2012, the gift should wait until the end of the year to eliminate the risk of a premature death in 2012. If a death would occur in 2012 after the gift was made, there is no federal estate tax yet an opportunity for a tax free stepped-up basis would be lost with the 2012 gift.
When assets gifted in 2012 are included in future estate tax computation, the source of payment of the estate tax must be considered. After the mega-gift the remaining estate value may not be sufficient to pay the estate taxes. If there is a $1 million unified credit equivalent and the total estate is $7 million including a prior $5 million gift, the remaining $2 million assets in the estate will not be sufficient to pay the federal estate, [55% of $6 million [7m - 1m] is $3,300,000].
Although Congress may not intend a clawback (taxing previous tax-free gifts), since 1976 the structure and history of the unified credit equivalent includes taxable gifts in the computation of federal estate tax. I doubt the 1976 unified credit approach of gift tax and estate tax will change. To increase the unified credit above the $5,120,000 and/or to add a credit equivalent to gifts made in 2012 appears to be improbable.
The Obama approach advocates a $3,500,000 unified credit federal estate tax equivalent and a $1 million unified credit gift tax and generation skipping tax unified credit equivalent. The Obama taxing approach favors taxing those of substantial means and it is not probable that a special tax dispensation will be given for those who made mega-gifts in 2012.
The Romney approach advocates the termination of death taxes but realistically with the national debt and deficit issues the federal estate tax will continue. The $5,120,000 index unified credit equivalent may simply be kept under this current unified credit philosophy.
The most likely short term scenario seems to be kick the can forward and delay the sunset for a year. To increase the unified credit equivalent above the $5,120,000 and to add a credit equivalent for gifts made in 2012 appears to be improbable.
The decrease of the unified credit for gift and generation-skipping to $1 million appears to be under serious consideration. Just because a gift is tax free when made has not stopped taxing the gift in the federal estate tax return with the past unified credit approach to gift and estate tax computation. If gift tax is paid when the gift is made, there is a credit for the paid gift tax on the federal estate tax return, although the gift tax credit on the Form 706 is the gift tax recalculated to the gift tax rates as of date of death not as of date of gift.
In making the decision of 2012 mega-gifts one must consider the tax basis of the gifted items, and whether the retention of assets is sufficient to pay federal estate taxes that are computed with the inclusion of previous taxable gifts. The donor needs to be aware that should the gifted asset decline in value, their estate will include the value of the gift at the date of gift not the value of the gifted asset at date of death. A critical question, is the donor willing to lose the dominion, control and income of the gifted assets?
There are benefits of making a lifetime gift such as removing future appreciation and income from the estate, and qualifying for $5.12 million generation-skipping transfer tax exclusions. In the final analysis for federal estate tax purposes there is a strong possibility that an estate subject to federal estate tax will be substantially the same regardless of whether the mega-gift was made in 2012, but hope springs eternal that Congress will give estate tax relief to those who have made mega-gifts in 2012. My view is contrary to the vast majority of estate planning professionals who anticipate an estate benefit for those making a mega-gift that will only be available in 2012. Some advisors are so bold to counsel a mega-gift is free of gift tax in 2012 will also be free of federal estate tax. Those receiving such counsel may be in for a rude awakening. Such an approach has no historic precedence and is simply in the hands of Congress and Presidential veto.
For estates well in excess of $5.12 million, a mega-gift may be prudent as long as the lost stepped up basis is not an issue. There is little to lose and a remote possibility of a great reward. Estates under $5.12 million should carefully weigh the advantages of making a mega-gift in 2012 and estates under $3.5 million should be cautious of whether the advantages of 2012 mega gift is warranted. Such analysis is by individual worth and a couple’s worth must be separated, as each has their own unified credit, in effect doubling the tax free estate tax planning opportunities. The probability of the unused unified credit to be used upon the death of a surviving spouse will expire the end of 2012 under current law.
Mega-gifting during 2012 is not for the faint hearted and should be done only with appropriate counsel of understanding the risks and advantages.
Frank C. Heinisch