Alert! The sky may be falling (again)!
This is the time of year when Earth passes through the tail of Halley's Comet and the annual Orionid meteor shower provides a spectacular show of falling stars. This year's show has some people mixed in with the meteors, i.e., James Bond is falling in Skyfall, and Felix Baumgartner accomplished a free fall from 24 miles high.
"The sky is falling!" is also what people say whenever the "Bush tax cuts" are about to expire. It has become a combination of Cinderella and Ground Hog Day. Our federal tax code may turn into a pumpkin at midnight at year's end by reverting to 2001 levels, and Congress has us reliving this crazy scenario over and over.
Let's look at year-end planning for this unique time.
3, 2, 1, Jump!
The view from 24 miles high is spectacular, and the prospect of breaking many records on the world's stage is alluring; however, placed in those circumstances, some of us might have told the world, "I've changed my mind about this jumping thing."
To jump from that height is literally a leap of faith. But consider the planning that leads to such a bold step. It is not a spontaneous decision based on a newly discovered opportunity; rather, it involves careful planning over a long period of time--with test jumps and attention to every detail--so that the results can be nearly certain.
Felix Baumgartner's jump represented extensive preparation. A 55-story helium balloon was needed to bring his capsule to the stratosphere, and a special space suit was required to withstand falling at 833 miles per hour.
Baumgartner broke the sound barrier. He broke the free fall height record. He broke the record for the highest manned balloon flight. He broke all kinds of jumping-from-space-type records.
The space jump was also a singular cultural moment. A record number of more than 8 million people watched concurrent live streams of the event on YouTube. The Twitterverse went into some kind of Tweeting frenzy, and Baumgartner's post-jump photo on Facebook got 216,000 "likes" within 40 minutes--demonstrating that the modern world is both amazing and annoying.
Note, however, that with a classy, old-fashioned nod, Baumgartner purposely popped his parachute at the 4-minute, 20-second mark so that he would NOT break the record for the longest free fall. The existing record of 4 minutes 36 seconds was set by Joe Kittenger in 1960 when he jumped from about 20 miles high. Kittenger, now age 84, had been assisting Baumgartner as the capsule communicator in the Red Bull Stratos project.
In all, Baumgartner spent more than five years of planning before his jump took place.
3, 2, 1, Gift!
As 2012 draws to a close, and our recurring "sky is falling" scenario of the automatic reversion to 2001 estate and gift tax rules is almost upon us, many people are contemplating whether they should take advantage of the current $5.12 million gift tax exemption before it expires. The gift tax exemption is scheduled to return to $1 million in 2013.
Estate planners are experiencing what it is like to suggest that clients consider giving away significant portions of their estate before the $5.12 million gift tax exemption expires. Some possible responses from clients:
"Give away HOW much?!"
A fleeting opportunity to minimize estate tax savings may be more appealing to estate planning professionals than to clients who are offered the chance to give away their assets.
For many people, those assets are difficult to part with because they were hard to come by over the course of a lifetime. Sacrifices were made to keep them. Watching them diminish in bad markets in recent years has been an ordeal. So it is not easy to embrace the concept of giving assets away on short notice. This is especially true when the motivating factor is not based on a firm and reliable tax code system with known rules but, rather, on the expiration of one favorable set of rules and the uncertainty of what may follow.
Give assets away and jump into a void? Some people would rather jump from the Red Bull Stratos capsule and plummet 128,000 feet. Which has the more certain outcome at this point?
Making a significant year-end gift in 2012 may be a lot easier for someone who is extremely wealthy. It is easier to justify giving away 10% of your assets than 50%. Making a significant gift is also easier if the donor is retaining sufficient assets to maintain the same lifestyle, income, and control over business interests.
However, logic may not enter into every situation. For example, Donor M, age 85, was finally convinced to set up an irrevocable trust for his grandchildren so that some of his assets could be moved out of his estate for transfer tax purposes, as well as for pre-Medicaid qualification purposes. The trust was set up. Some assets were moved into the trust.
But, at the last minute, Donor M refused to transfer $500,000 of assets. The reason? He wanted to be able to directly control how the assets were invested. It did not matter that the trustees would do exactly as Donor M told them. It did not matter that the assets in question were in long-term municipal bonds that Donor M never reinvested anyway. Having an irrelevant level of control was more important to Donor M than reducing future transfer tax liabilities.
Pondering Gifting Outcomes
What level of tax savings are at stake with a year-end gift in 2012? Must the gift be $5.12 million to obtain the full advantage? Or should a wealthy married couple transfer $10.24 million collectively?
Example #1: If all the stars were aligned for a grantor in 2012 and $5.12 million was given before year's end with 1) no prior gifts having been given; 2) a reversion in 2013 to the $1 million exemption for gifts and estates; 3) no "claw back" recapture of taxes saved by the 2012 gift; 4) no subsequent increase in the estate tax exemption before the grantor's death; 5) no use of annual gift tax exclusions or other estate planning techniques; and 6) an applicable tax rate of 55% based on the grantor's taxable estate, then the net outcome would be the exposure of $4.12 million of funds (assuming no appreciation or depreciation from those funds) to a tax rate of 55%.
So a maximum gift in 2012, with all conditions being exactly right, could have a maximum savings of $2,266,000.
Example #2: Now let's change the assumptions so that the ultimate exemption turns out to be $3.5 million with a top estate tax rate of 35%, i.e., one of the more plausible scenarios. If the grantor maximized his 2012 gift, an extra $1.62 million would be transferred and would avoid a 35% estate tax, saving $567,000.
A number of other benefits apply: