Last night was a very interesting evening. As the guest of my good friend Dennis Rosa, a wealth manager at Morgan Stanley Smith Barney, I attended Morgan Stanley’s annual gift to the Northeast Florida community of bringing Andy Friedman to town.  Andy Friedman is probably the most knowledgeable, brightest, and politically well connected lawyer in Washington, DC.  He’s a prolific writer, and regular guest on CNBC’s Squawk Box.  He writes the Washington Update and is known as “Wall Street’s Tax Expert.”


As usual, Friedman was outstanding in his presentation and gave what can only be considered as an objective analysis of what Congress, and the White House, is likely to do with tax policy over the next few years.  While most of Friedman’s comments were directed to the budget deficit, the impact on the markets and investments from the actions – or inactions – of Congress, and other macro economic issues, he also spoke briefly of what he termed an “exceptional” opportunity that is presented by certain provisions of the estate and gift tax code that are available only for the years 2011 and 2012.

For the remainder of 2011 and the year 2012, the federal estate and gift tax provisions of the Internal Revenue Code (“IRC”) allow a $5 million exemption from the gift tax that is imposed on lifetime transfers of assets.  Essentially, anyone with the ability, can gift up to $5 million to another person, without incurring a gift tax.

Pursuant to the estate and gift tax provision of the IRC, a gift to any one person in excess of the annual exclusion ($13,000 for 2011) that is made in any given year is subject to a transfer tax that is called a “gift tax.”  The “taxable gift” is the value of the gift in excess of the annual exclusion amount ($13,000).  The current gift tax rate for 2011 and 2012 is 35% of the value of the taxable gift.  For example, a taxpayer who makes a “taxable gift” to an individual in the amount of $1,000,000, will also have a gift tax liability to the IRS of $350,000.

Each individual has a lifetime “exemption” from the gift tax. The amount of that exemption has varied over the years with the changes in the estate tax exemption amount.  Typically, the life time exemption for the gift tax is the same as the estate tax exemption.  The gift tax and the estate tax are “unified,” which means if you use your gift tax exemption during your lifetime, it will reduce the amount of estate tax exemption you have at death – dollar for dollar.  The lifetime exemption for gift taxes, and the estate tax exemption, for 2011 and 2012 is $5,000,000.

Neither Andy Friedman nor anyone else knows what Congress and the White House will end up doing with the estate and gift tax after 2012.  If there is no action by Congress on the gift and estate tax by the end of 2012, the tax structure will revert back to is 2001 levels.  That will mean a $1,000,000 lifetime gift tax exemption, and $1,000,000 estate tax exemption.  The tax rate will also zoom from the current 35% to 55%.  Using the example from above, if Congress is deadlocked through 2012 on tax issues, that same $1,000,000 “taxable gift” will potentially generate a $550,000 gift tax payable to the IRS.

Hence the “exceptional” planning opportunity for the next year and a half.  Utilizing the $5,000,000 exemption while it is available creates a number of exciting (yes – “exciting”) plannning opportunities.  These opportunities include the following:

                    •     $5,000,000 gifts in trust 
                    •     Spousal access trusts 
                    •     Life insurance trusts 
                    •     Dynasty trusts 
                    •     Income shifting family trusts 
                    •     Asset protection trusts

$5,000,000 gifts in trust

The simplist way to take advantage of this opportunity is to gift up to $5,000,000 to an irrevocable trust for the benefit of a spouse, children, grandchildren, or others.  All of the growth of those assets between the time of the gift and the death of the person making the gift will be outside the donor’s estate.  The growth will escape estate taxes at death – which upon reversion to the $1,000,000 exemption and 55% tax rate could be quite significant.

Spousal access trusts

A spousal access trust is an trust in which the person making the gift places the funds in a trust for the benefit of their spouse.  The spouse is entitled to the income generated by the assets in the trust, and can have the level of access to principal that is most advantageous to the couple – from no access to the principal to virtually total access to the principal.  The tax advantages can significant.  Not only do you remove from the taxable estate of the person making the gift the growth of the assets between the gift and the death of the donor, but you also provide assets, in a properly drafted trust, that can be utilized to take advantage of the spouse’s exemption from estate taxes where the spouse may have assets totaling less than the exemption amount.  Essentially a two dollars of tax advantage for every one dollar of gift.

Life insurance trusts

Life insurance trusts have been a mainstay of estate tax planning since the estate tax came into existence in 1913.  With a $5,000,000 exemption amount, the leverage provided by life insurance makes this one of the most “exceptional” planning options.  That’s especially true if you have a couple with a younger spouse and a survivorship (second-to-die) life insurance policy is used.  The multiples of wealth that can be generated are huge!  The use of a second to die policy for couples where at least one spouse is in their 50s or 60s can generate life insurance proceeds that are many multiples of the amount of the gift made to the insurance trust.  Combining the gft tax exemption and the generation skipping tax exemption creates the opportunity to gemerate wealth that can benefit successive generations of your family for upto 360 years in Florida.

Dynasty trusts

A dynasty trust is a trust that is designed to be used for the benefit of those successive generations, for up to 360 years in Florida.  There are a couple of states that contain no limit to how long a trust can last, and those states laws can be used to establish the trust in perpetuity.  If both the gift tax exemption and the generation skipping tax exemption are applied to a dynasty trust, it will continue for as long as the state’s law allows and never be subject to the gift, estate or generation skipping tax.  Coupled with the leverage that can be achieved through the use of life insurance, and the survivorship policy in particular, the planning opportunity goes beyond “exceptional” and perhaps should be considered “phenomenol!”

Income shifting family trusts

Through the use of various trusts techniques, with the $5 million exemption, it is also possible to accomplish significant income shifting among family members.  Income shifting in the new “normal” is going to become increasingly important.  There is absolutely no doubt – at least according to Andy Friedman – that income tax rates are going to increase.  There either will be pure increases in the income tax rates, or the elimination of various deductions that will subject more income to income taxes.  Either way, shifting income from higher tax bracket individuals to lower tax bracket individuals will be desirable.  The current use of the $5 million exemption from gift taxes provides a mechanism to signficantly shift income and potentially save signficant income tax liabilities after 2012 when those increased rates are sure to come.

Asset protection trusts

A number of states, notably Nevada, Alaska, Delaware, and about 10 other states, have enacted legislation that allows the use of domestic asset protection trusts (“DAPTs”) in those states.  Those statutes have been in place now for about 15 years.  Skepticism surrounded the adoption of the asset protection trusts legislation for those states.  However, they appear to have stood the test of time.  The courts of those states have accepted them as appropriate planning techniques.  The use of a domestic asset protection trust situated in one of those states, funded with the $5 million gift tax exemption amount, can provide safety and protection from creditors in the event an adverse judgment is entered against you creating personal liability.

The listed options are only the most apparent and clear techniques that can be used to take advantage of what Friedman termed an “exceptional” opportunity that may last for only the next year and a half.

If you would like to explore your options for exploiting this exceptional planning opportunity, let us know.

And by the way, my friend Dennis Rosa is an exceptional asset manager.

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