Gifting with the Ability to Get It Back

Gifting with the Ability to Get It Back

Introduction

Tax Exemption

Clawback

The Dilemma

Irrevocable Trust

Gift and Death Tax Result

Step Up in Basis

Conclusion

Dear Mr. Miller: I know there is a $5 million dollar gift tax exemption right now and that it goes away come January 2013. I am single and have $10 million. If I can take advantage of the current exemption I will save my children the tax on $4 million when I die. That may be as much as $2,200,000!

I want to gift to my children now so they don’t have to pay death taxes later, but I may need that money. I guess I want my cake and want to eat it, too. Can I do that?

Avoid Tax at All Costs

Dear Avoid Tax at All Costs: Tax Exemption: Actually, the gift tax exemption (and the death tax exemption) right now is $5.12 million. Potentially, twice that for a married couple. But let’s not quibble over small amounts, we’ll just call it $5 million.

Clawback: As the law that is in place right now reads, that exemption will drop to $1 million on January 1. If you give the $5 million gift now, the way the gift tax and death tax interrelates, there is a question as to whether the exemption at the time of the gift ($5 million) or at the time of the death (potentially $1 million) ultimately controls. This has been referred to as the “clawback” issue.

Many commentators are quite convinced that, assuming the $1 million exemption actually comes back (which means Congress fails to act to preserve the present exemption), the exemption at the time of the gift will control ($5 million). In other words, the government does not get to “clawback.”

The Dilemma: Obviously, if you have $1 million or are married and have less than $2 million, this whole controversy is pretty much irrelevant. But if you have more, then from a purely tax perspective, you should give it away now. Of course, one cannot make all decisions based on taxes alone. There are other concerns; such as, do you have enough to live on after you make the gift. Even if you do, how do you know you won’t need it back in the future because your health has declined and you need more, etc. So unless you have far more than you will give, one has to be concerned about the ability to get it back.

Irrevocable Trust: One way to approach this problem (make the gift now to take advantage of the $5 million exemption but yet have the ability to get it back if you need it) involves irrevocable trusts. So here’s the concept. Gift $5 million to an irrevocable trust for the benefit of your children or grandchildren. After the gift the parent would be entitled to purchase some or all of the assets in the trust in exchange for a promissory note. The note could be interest only and call for payoff 30 years down the road. The purchased property would serve as collateral for the loan payments.

Gift & Death Tax Result: The parent could exercise his ability to purchase the property for the promissory note at any time that he felt he needed the assets. In other words, he has the ability to “get it back” in exchange for interest only payments. Assuming he did exercise that right, the note would probably not be paid off at the time of death. The assets purchased ($5 million assuming none was used to support the parent) would be part of the parent’s estate at death and subject to death tax. However, that would be offset by the promissory note which would have an outstanding balance of $5 million. And, assuming no clawback ability, the original gift would also not be taxed as it would be covered by the $5 million exemption that existed at the time of the gift (whether or not the exemption falls back to $1 million).

Step Up In Basis: Better, the purchased assets owned by the parent at time of death would receive a new income tax basis equal to the fair market value at that point in time (i.e. step up in basis).

Conclusion: As always, there are a lot of potholes and in’s and out’s here. So don’t try this on your own; you need quality, competent legal advice if you want to take this route. But remember, these types of transactions are complex; they can’t be accomplished in one day or even a few days. With the deadline being January 1, don’t wait until December to get started. It has to be started now!

11/2012