Historic Opportunity to Avoid Tax on Over $10 Million+ of Assets
Every year, we remind our clients that year-end gifting is an easy, tax-efficient way to reduce their taxable estate. This year, the message is all the more significant because this year, for the first time, a person can gift up to $5 million of assets and get $5 million out of the reach of the estate and gift tax ($10 million for a married couple). This means that if your net worth is below $5 million ($10 million for a married couple), you could avoid gift and estate taxes entirely. If your net worth is above $5 million, that amount can still go to your family and loved ones, tax free. If your assets are owned by family limited partnerships (FLPs), then even more can be gifted out of your estate via the principle of discounting, as discussed below.
The amount that an individual may gift to another individual, without tax consequences or a reporting requirement, is now $13,000. Gifting is an effective strategy to utilize in reducing estate tax liability. For example, if a husband and wife each gift $13,000 to three children, the value of the couple’s estate is decreased by $78,000.
In addition, you may utilize your “unified lifetime credit” to avoid gift taxes and make one or more gifts of limited partnership interests equal in value to $5,000,000 ($10,000,000 together with your spouse; total value for all gifts). You will be required to file a gift tax return, but the gift taxes will be offset by your $5,000,000 unified lifetime credit. A husband and wife, together, may make joint tax-free gifts equal in total value to $10,000,000 in this manner. Read that again. Yes, $10 million in assets passing to your heirs, free of tax!
Clients with FLPs should consider gifting an equivalent amount of limited partnership interests, so as to decrease the value of their estate. Clients have until December 31, 2011 to effectuate a gift for calendar year 2011. Clients should, in fact, make annual gifts of limited partnership interests, so that the value of their estates, over time, will decrease for estate tax purposes. As long as clients retain their general partner interests, clients will continue to control all assets within their partnership. Yes, you can escape the estate tax and still control the assets.
Gifting of partnership interests works hand-in-hand with the principal of discounting of those interests. Once discounted, more FLP interests can be gifted tax-free to the next generation, which results in more assets passing out of an individual’s taxable estate and thus decreased estate taxes.
One short example may clarify how discounting and annual gifting work together to lower estate tax liability. If a client owns real property valued at $130,000, the client might gift the property to his or her child over a ten year period ($13,000 annual gift tax exclusion, over ten years). However, if the same property is owned by an FLP, the client may claim a 50% discount in the value of the limited partnership interests (for lack of marketability and lack of control). Now, with a discounted value of limited partnership interests of $65,000 (50% discount on $130,000), via annual gifts of $13,000 worth of partnership interests, it would take the client only five years to gift away her partnership interests and eliminate estate taxes due on that property. This is because a $13,000 gift equals 10% of the non-discounted FLP value ($13,000 = 10% of $130,000), but $13,000 equals 20% of the discounted FLP value ($13,000 = 20% of $65,000).
The same discounts, applied to an FLP containing $20,000,000 of non-liquid assets would allow for the total elimination of estate taxes on the $20,000,000 via a tax-free gift of $10,000,000 worth of limited partnership interests by a husband and wife.
Further, in the current recessionary economy, now is the time to consider gifting assets that are presently at abnormally low values. The severe decline in the stock and real estate markets have created further built-in discounts for many assets. When the economy rebounds, these assets will begin to increase in value, and that future appreciation will occur outside your estate.
Furthermore, it is likely that the federal government will make unfavorable changes to the estate and gift tax laws in order to compensate for government deficits. If passed by Congress, proposed legislation will eliminate the ability to discount the value of FLP gifts. Clients should consider taking advantage of current favorable laws while they still exist. The $5 million gift and estate tax exemption only applies during calendar years 2011 and 2012. Thereafter, the exemption will go back down to $1 million. Now is the time to capitalize on this window of opportunity to avoid gift and estate taxes on a lot of your assets.
We realize that these are not simple concepts, and we welcome your questions. We can advise you as to appropriate FLP discounts, prepare memoranda of gift for you, as well as the partnership valuation and gift valuation calculation letters (necessary for the IRS). Please contact us.