Is 2012 the Year for You to Make a Significant Gift to Your Family Members?
What Makes 2012 Special?
2012 may be the ideal year for Washington residents to make gifts. The combination of the current Washington State tax laws and the change in the federal transfer tax structure presents a unique opportunity for residents to make large gifts to reduce the impact of the State estate tax.
Federal Exemption and RatesThe current exemption from the federal gift and estate tax is $5.12 million through 2012 (as indexed for inflation). However, in 2013, the exemption will be reduced to $1 million, pending further action by Congress to extend the current exemption or establish a new one. The current top marginal gift and estate tax rate is 35 percent. If Congress fails to act before 2013, the highest marginal rate will increase to 55 percent.
State Exemption and Rates
In addition to the federal estate tax, Washington State residents are subject to a State estate tax. There is no tax on the first $2 million in value of assets owned at death. The tax rate is progressive and begins at 10 percent on assets above $2 million up to $3 million and is capped at 19 percent on assets over $11 million. Incidentally, this 19 percent estate tax rate is the highest marginal state estate tax rate in the country.
This means that the estate of a Washington resident who dies in 2012 is subject to the State estate tax for assets over $2 million and the federal estate tax for assets over $5.12 million.
Annual Gift Exclusions
The federal estate tax is coupled with the federal gift tax. In addition to the lifetime exemption noted above, each individual receives an annual exclusion from the application of the federal gift tax for gifts of cash or other assets up to $13,000 in value. In each calendar year, donors can make as many gifts as they want to different people and receive a $13,000 exclusion for each gift recipient. The annual exclusion gifts do not reduce a donor's lifetime exemption.
How Can a Taxable Gift Help My Heirs?
The federal gift and estate tax exemption of $5.12 million and the lifetime exemption of $5.12 million are unified under current law, so that if a donor makes a taxable gift during his or her lifetime above the $13,000 exclusion, the value of the taxable gift reduces the donor's estate and gift tax exemption by the amount of the gift in excess of $13,000. A "taxable gift" is a gift that uses the donor's federal lifetime exemption.
Washington State, like most other states, does not currently impose a gift tax, and the State's $2 million estate tax exemption is not reduced by lifetime gifts.
For example, if the estate of a Washington resident who dies in 2012 is valued at $5 million, the estate would owe $390,000 in State estate tax attributable to the value of the estate in excess of $2 million (Washington State’s exemption). No federal estate taxes would be due assuming no taxable gifts were made during the person’s life that would have reduced the federal estate tax exemption below $5 million. If, however, prior to the person’s date of death, a gift of $3 million was made to the person’s children, the estate would pay no estate taxes, either State or federal, under the current tax structure. Thus, an individual can significantly reduce the anticipated Washington State estate tax by making gifts, and can potentially eliminate all estate tax by reducing the taxable estate below the $2 million State estate tax exemption threshold.
What Else Should I Consider?
Prior to making any gift, a donor should understand the income tax consequences of doing so. When property is sold or exchanged, the owner's gain or loss is usually determined by deducting the basis of the property (usually the initial cost of the property) from the amount received. For example, if an owner sells property for $15,000 that has a basis of $10,000, the owner has a gain of $5,000. Under the general gift rule, the donor's basis in the property carries over to the donee. An important exception to the general rule provides that a donee's basis in gifted property is limited to the value of that property at the time of the gift if the property is later sold for a loss.
These income tax consequences must be compared to a recipient's basis of inherited assets. When an individual receives an asset from a decedent's estate, the income tax basis in the asset is generally equal to the asset's fair market value as of the date of death. Accordingly, it will be important to consider income tax consequences in selecting assets for gifting purposes.
Today's depressed values offer significant opportunities for transfers of wealth. For gift and estate tax purposes, the value of the asset is equal to the asset's fair market value at the time of the transfer. Recently, many individuals have chosen to give real estate or business interests to family members. The current fair market value of real estate and business interests may be depressed as a result of current market conditions. Thus, a donor can give a larger portion of the asset than would have been possible a few years ago. By giving a fractional interest in a piece of real estate or a minority interest in a business, the donor may also explore the possibility of a reduced value for the interest due to the lack of marketability and/or the lack of control associated with such interest. Typically, the valuation determination of real estate and business interests requires a professional appraisal.
Can I Change My Mind?
It is important to remember that gifts are irrevocable. While it may be appealing to make a large gift to avoid estate taxes, a donor should first analyze whether the donor may need the asset or the income from the asset in the future. If so, it may not be advisable to make a significant gift, and perhaps other planning strategies should be considered.
We would be pleased to confer with you to determine whether the time is right for you to make a significant gift or to consider other planning strategies.
This update was written as a follow-up to a recent article published in the Puget Sound Business Journal titled "Washington Residents Have an Incentive to Give," written by Colonel Betz and Steven Schindler.
© 2012 Perkins Coie LLP