TAX NEWS - JUNE 2010

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U.S. Tax: Time running out to exploit gift tax break

U.S. gift tax rates are the lowest since the Depression, but advisers say rich clients are refraining from giving money to heirs because they are still reeling from losses they suffered during the financial crisis.

Under a tax plan instituted by the George W. Bush administration, top gift tax rates this year fell to 35 percent from 45 percent in 2009. Americans can transfer assets from their estates at a lower tax rate and reduce their estate tax liability ahead of a planned spike in that rate to 55 percent next year, estate planning attorneys say.

Yet the rich have kept a tight hold on their money.

"People are still stinging from the recession and they're hesitant to change things," said Martin Shenkman, a Paramus, New Jersey, estate-planning attorney. "Instead of seeing this as a great opportunity to do something, they're doing nothing."

Sue Stevens, a Deerfield, Illinois-based financial planner, said even her wealthiest clients are reluctant to give away their money after seeing their fortunes diminish during the financial crisis.

"Everyone is scared they're going to run out of money," said Stevens. "But I tell them that, with rates going up, this is a pivotal year for tax planning and we need to be thinking of every opportunity."

And the cost of doing nothing could be high. Lawmakers have been debating changes to U.S. tax policy. If Congress fails to act, as happened last year, the top gift and estate tax rates will jump to 55 percent in 2011.

The 2010 gift tax rate is the lowest since 1934, when the rate was 33.5 percent, according to a study by tax publishing company CCH.

Each year, individuals can make a gift of $13,000 to any number of people without incurring gift tax. They can also give $1 million over this amount during their lives without paying a gift tax.

But wealthy clients who may want to give more than that will be hit with a big tax bill.

While it can be a hard sell to convince clients that writing a big check to Uncle Sam is in their best interests, it is often prudent to pay gift tax now to help heirs avoid estate taxes later, said David Handler, an estate planning attorney at Chicago firm Kirkland & Ellis.

Gift and estate taxes usually are set at the same rate, which varies from year to year, although because of wrinkles in the U.S. tax code, gift taxes end up making less of a dent in family finances.

A $1 million gift with a tax rate of 50 percent, for example, may cost $500,000 in taxes for the donor, but the recipient still gets a cool million. When that gift arrives as an inheritance, 50 percent goes to the government before the heir sees a penny.

That is the usual scenario, but 2010 is different. The gift tax is 35 percent this year and there is no estate tax, while next year both are set to jump to 55 percent.

There are also other benefits to making gifts. Clients can see their children enjoy their inheritance and also monitor how they deal with the money. This can influence how clients structure their wills, said Handler.

Handler recommends clients give as gifts assets that can get a valuation discount. If clients own companies worth $10 million, they could decide to give 20 percent of the stock to their children.

That 20 percent stake will be valued at less $2 million for tax purposes. Under IRS rules, the stake loses value because the child does not have control of the company and the stake may be difficult to sell.

Some financial advisers may actually be impeding gifts, lawyers say.

"Many advisers don't want to suggest to a client that they pay a big tax bill before they have to. They like to pretend they can use their magic to minimize taxes, but that never works," said Handler.

However, it could be an easier concept to swallow this year with many investors converting regular IRAs to a Roth IRA, forcing them pay taxes on the funds now to make tax-free withdrawals after they retire.

"They're paying taxes now to save taxes in the future. It's the same concept," said Handler.
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