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Handicapping the Future Estate Tax Exemptions

Gift-Tax-RulesBy: Mark L. Dodds, Esq., Partner at Grant Morris Dodds

So here we are, more than one year after the change in the estate tax law which temporarily at least has repealed the 2010 repeal of the estate tax, replacing it with a $5 million exemption. But the $5 million exemption is not all bad, considering most estate tax pundits never would have predicted the repeal would have seen the light of day, even for the one year for which the repeal actually was effective.

There were several high profile deaths in 2010 where the heirs really hit the jackpot,  among the most notable being the heirs of George Steinbrenner who inherited the $1.5 billion New York Yankees franchise entirely free of estate tax. If Mr. Steinbrenner had died one year earlier, the heirs would have had the federal government as a 55% partner in the storied New York team; had Steinbrenner died a year later, in 2011, the federal government would have been only a 35% partner. Either way, Mr. Steinbrenner got it just right, assuming there can be a right time to die.

What, then, is the future of the estate and gift tax? There are many people of reasonable means who are taking advantage of the $5 million estate AND GIFT tax exemption by making tax exempt gifts during the 2-year period during which the $5 million exemption is in place. The theory is that by taking advantage of the current $5 million gift exemption,  even if Congress does not extend the $5 million exemption and make it permanent, once the tax exempt gift is made utilizing the exemption, it would be hard for Congress to take the tax exempt status of the gift back.

As a practical matter, I think taxpayers are correct in thinking that it would be unlikely for Congress to take back the exemption once it has been used. However, due to the manner in which the estate tax is calculated, if Congress does not take the positive act of making the $5 million exemption extend beyond 2012, then without legislation, the heirs of persons who used the $5 million exemption by making gifts in 2011 and 2012 could be faced with an estate tax on property that was gifted to them in 2011 and 2012. This result would occur because, in calculating the estate tax, the procedure is to add back to the estate value the value of all gifts made by the decedent since 1976.

Then once the estate is properly “grossed up,” as this process is called by practitioners of the art, the exemption available at the date of death, not the date of the gift, is applied to the estate. So the problem this creates is that the exemption applicable at the time of death may be less than the exemption which applied at the time of the gift, with the result that there could be “stealth” estate tax resulting from a decrease in the exemption. Thus, the scenario can be imagined where a decedent has only a minimal estate left at death, but where upwards of a $1 million in estate tax might be due. Where will the IRS look for payment of this “stealth” tax where the estate was previously gifted? Will it look for contribution from the beneficiaries of the prior gifts?

That does not seem likely as the gift tax and the estate tax are liabilities of the donor and the donor’s estate. The donee of a gift has no obligation for payment of gift taxes unless the gift was made as a “net gift” in which the donee legally assumes the obligation for the gift tax. And certainly, someone who received a gift many years before the donor’s death cannot reasonably be called upon to pony up for the stealth estate tax. This same unfortunate result could also ensue if the estate tax rates are increased from current levels.

In order to avoid such a result, Congress will need to act to either i) maintain the gift exemption at $5 million or more (as based upon current estate and gift tax rates), while not increasing the estate tax rates, or ii) enact legislation which would preserve an exemption previously taken, even if the law later reduces the exemption.

It is my opinion that Congress will take steps by year-end to avoid the possibility of this stealth estate tax. Considering that year-end will see more changes in Congress and the Senate resulting from the 2012 elections, it should be an interesting last few weeks of the year again. In any event, for those who have the means, utilization of the $5 million gift exemption should be considered for utilization in 2012.

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