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Riding the 2012 Trust Tsunami

May, 2012

How to Prepare for the Lapsing $5 Million Gift Tax Exemption

By Richard P. Trumpler, TEP.

Use the Summer Lull to Get Your Clients Ahead of a Stormy Tax Season Summer is traditionally when investors leave town and many advisors catch up on paperwork, vacation time or sleep. But this year, signs of a storm on the horizon mean that far from lightening up on your client outreach activities, it’s time to double down.

Tax planners have been wary about the looming simultaneous expiration of various rates, rules and exemptions — usually lumped together as “the Bush tax cuts” — for years.

But this year, depending on November election results, we could actually see the long-dreaded “taxageddon” come true.

Now is the time for all advisors to contact every client with more than $3 million in investable assets to make sure that they understand that the window to take advantage of the best gift tax environment in history may be closing fast.

Death is inevitable, but many estate and gift taxes are not. High-net-worth families will never have a better opportunity to reduce their taxable estates through tax-free gifting.

Your clients may not be watching their account balances this summer, but even if you only provide a simple illustration, the math should convince anyone about the high price of delay.

Assume that a married couple gifts $10.24 million in assets to their children. If the gift occurs in 2012, the full amount of the gift falls within the federal lifetime gift-tax exemption. If the couple waits until 2013 and present law is allowed to lapse, only $2 million would fall within the lifetime gift tax exemption. With the top estate tax rate set to increase to 55%, locking in the 2012 rules adds approximately $4.5 million to the after-tax wealth the couple’s descendants can enjoy.

Ideally, this example will make your clients more receptive to revisiting their gifting programs before the end of the year.

It also helps to provide a concrete profile of the type of investor who stands to lose the most by any extensive rollback of the tax code.

Any clients who see themselves falling into the following categories will be especially motivated to take action:

  • Estate Size: Gifting strategies are important this year for individuals with estates greater than $1 million because next year the tax-free gifting limit may be $1 million. Obviously, the larger a client’s estate, the greater the motivation should be to consider maximizing gifts in 2012.
  • Age/Health: A key element of any gifting strategy is to determine how much the donor can afford to give away and maintain current lifestyle needs. A 90-year-old donor in poor health with a $6 million estate may feel comfortable giving away $5 million. A 40-year-old with $100 million may not be comfortable giving away a dime since, as Jim Morrison noted, the future’s uncertain and the end is always near.
  • Ego: Woody Allen once noted that he did not want to achieve immortality through his work; he wanted to achieve immortality by not dying. For the rest of us, an important motivator behind any gift is the donor’s desire to be remembered. The advantage of using lifetime gifts — philanthropic or otherwise — is that the donor can experience the happiness that their gift creates while they are still alive.
  • Tax Protest: Large gifts can be very emotionally rewarding to a donor who believes that government is big enough and should only receive the minimum amount of taxes that his or her estate is absolutely required to pay.

Overcoming Resistance

It is easy to understand who can most benefit from making large gifts in 2012. So why do wealthy individuals fail to use what may be a once-in-a-lifetime opportunity to pass a large amount of assets out of their taxable estate?

In order to have a rational conversation with a client about the need to consider estate planning strategies, the reasons for resisting those strategies must be determined and met with solutions. A few of the big reasons for resistance include:

  • Pure Procrastination: It is a Scottish proverb that “What may be done at any time will be done at no time.” For example, 40% of Americans have no will. Certainly two out of five people you meet on the street do not think that they are never going to die; they simply believe that they are not going to die soon, and so they put off planning until it’s too late. Procrastination is a strong obstacle to implementing gifting strategies.
  • Laziness: Estate planning is hard work. It requires an individual to compile a list of all assets and make sometimes difficult decisions about family relationships, two tasks which are tedious at best. They must ponder their own mortality and think about the future of their family, which is depressing. They have to consider taxes, which nobody enjoys. And while wrestling with many unresolvable uncertainties, they need to pay a lawyer. Overcoming these serious negative incentives is not easy even for the truly motivated. For everyone else, it’s next to impossible.
  • Age: The comedian Steven Wright asks the question: How young can you die of old age? Of course everyone is “too young” to consider the plan for their estate and estate planning is generally considered to be a task for the old, so if you begin to plan for your estate, you must be old. Very few people will admit that they are old.
  • Control: Jack Welch famously noted that if you are not in control of your destiny, someone else is. Wealthy individuals have often spent most of their life controlling their financial affairs and the notion of surrendering any control of those affairs is a very difficult concept for them to accept. Any type of gifting strategy involves some loss of control of the donor’s wealth because true gifts — unlike trusts — always come with no strings attached.
  • Fear: All parents want the best for their families. A constant fear of many wealthy parents is that a large inheritance or a large gift will make it more difficult for the gift recipient to find a purpose for their life. As Warren Buffet put it, they want their children to have enough to do anything, but not enough to do nothing.

Overcoming client objections regarding this subject may not be possible. That’s okay. But do your best by giving your clients some options.

Gifting Options

Presenting ideas that address your client’s reservations can help persuade him or her to act in their family’s best interests. Know the difference between gifts and trusts and be prepared to help your client investigate the choice that best meets his or her emotional needs.

Outright gifts – Any conversation about gifting strategies with a client should always include the simple advice that outright gifts to family members may make sense. While the choice of assets to give can become complex, sometimes keeping things simple is excellent advice. One simple tactic to consider is to forgive any outstanding loans to heirs. And remember, making outright gifts to charities has always been an effective tool for reducing the taxable value of an estate.

Trusts – For any number of reasons, a client may be reluctant to make a large outright gift to any family member. However, that does not mean that they should not transfer assets out of their estate. Gifts to a trust can reduce their estate and maintain some control over how the gift is used.

A carefully created trust can achieve a number of goals and overcome many client objections to gift planning. A few of the major types of trust include:

  • Asset Protection Trusts. A prospective donor is often worried that an emergency may arise which may require them to draw on previously gifted assets. An asset protection trust may be an ideal solution to this problem. Gifts can be made to such a trust to accomplish estate planning goals. However, the trust can be structured with the donor as a beneficiary, allowing him or her to draw on its assets in extremis while protecting those assets from the claims of donor and beneficiary creditors.
  • Dynasty Trusts. A trust can last for at least a generation or two under many circumstances. However, if a donor is interested in creating a truly long-term legacy or simply interested in ensuring that the immediate heirs do not squander the family fortune, it is easy to create trusts which will last for centuries by restricting the ability of beneficiaries to request distributions of trust assets in the process.
  • Spendthrift Trusts. It is common for parents to trust their own children’s financial wisdom but to have very little trust in the ability of sons and daughters-in-law to behave in a financially responsible manner. Gifting to a trust protects family assets from the creditors of blood relatives and from the claims of donor in-laws, beneficiary in-laws, beneficiary ex-spouses or the children of a beneficiary’s second spouse.
  • Incentive Trusts. Using gifts as a motivator for desired behavior is a venerable parenting technique that goes all the way back to that first allowance in exchange for mowing the lawn or a reward for achieving good grades. Trusts can also be funded for the purpose of motivating children by including incentives. For example, a beneficiary may ineligible for trust distributions until receiving a college degree.
  • Business succession planning: Finally, trusts are an extremely useful vehicle for transferring business interests. If a client’s business represents a large part of the family’s net worth, gifting some or all of that business to a trust can be a very effective method for transferring large amounts of wealth in a tax-efficient manner. Such a gift can also be combined with valuation discounts to get the most bang for the gift buck, and selecting a tax-advantageous state such as Delaware can mitigate state capital gains taxes on the sale of the business in the trust

Bottom Line: There is no more powerful client retention tool than helping him or her pass on wealth, and there is no more powerful introduction to a new client than being the person who urged the wealth transfer in the first place.

Taxageddon may not actually arrive this year. The incoming Congress may ratify the existing tax rules for the long term or at least pass the buck to 2014 and beyond.

But remember, it is exceedingly rare for all estate planning lawyers to agree on any subject. The fact that all estate planning lawyers agree that there will never be a better time than 2012 for wealthy clients to use gifts as a strategy to reduce their estate is an ominous storm warning.

The time to act is now.

For further information, please contact Kevin Batterton, 212.850.4055,

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