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ESTATE PLANNING SERIES – ESTATE AND GIFT TAX REFORM. Part 3: The Proposals for Estate and Gift Tax Reform Have Begun: Analysis and Considerations Regarding Annual Gift Tax Exclusion

This article is the third installment of a three-part series by Erica Williams that will highlight specific topics contained in recent tax reform proposals that may impact your estate plan.  The first installment discussed the proposed changes to the estate and gift tax exemptions.  The second installment discussed grantor trusts and how the use of such trusts may change if the proposals become law.  This third installment discusses the effect that the proposed changes to annual exclusion gifts would have on certain transfers.

By Erica K. Williams, Esq.

The Internal Revenue Code imposes a gift tax on transfers of property from one person to another. However, there is an “annual gift tax exclusion” amount that an individual may transfer to another without incurring a gift tax or affecting the individual’s lifetime exclusion amount. By utilizing the annual gift tax exclusion, an individual can give $15,000 per donee annually gift-tax free, with no limit on the number of donees. For a married couple, this amount increases to $30,000 per donee if certain requirements are met. The annual gift tax exclusion is indexed for inflation. In order to qualify for the annual gift tax exclusion, the gift must be of a “present interest in property,” meaning that the recipient must have immediate access to, and use of, the gift.

An advanced estate planning technique that provides the ability to leverage the annual gift tax exclusion is to give beneficiaries of an irrevocable trust the right to withdraw a pro rata portion of any contributions made to the trust. This right to withdraw converts an otherwise “future interest” gift to a “present interest” gift that qualifies for the annual gift tax exclusion. For example, if a trust has ten beneficiaries, a married couple could transfer up to $300,000 to the trust annually without incurring a gift tax or eating into their lifetime gift tax exemptions. This technique has proven to be an effective means to remove significant assets from an individual’s taxable estate. Unfortunately, if legislation similar to that proposed under the “For the 99.5% Act” becomes law, the benefits of using this technique will largely be gone.

The tax law reform legislation proposes to severely limit the annual gift tax exclusion with respect to certain transfers, including transfers into an irrevocable trust. The “present interest” requirement would be eliminated and a cap would be placed on the amount a donor can transfer to the trust without incurring a gift tax or utilizing the donor’s lifetime gift tax exemption amount. As proposed, the current $15,000 per donee annual gift tax exclusion amount would be replaced with a $30,000 per donor limitation for these certain types of transfers. This limitation, coupled with the proposed reduction of the lifetime gift tax exemption to $1 million discussed in the first installment, will have a dramatic impact on traditional gifting to irrevocable trusts. Consider the example stated above. Should the proposed legislation become law, the amount the married couple could transfer to the trust each year without incurring a gift tax or using their lifetime gift tax exemptions would be limited to $60,000.

If you have an irrevocable trust funded with annual gifts (i.e., an insurance trusts to which gifts are made to pay an annual premium), consideration should be made to shift value to those trusts before any such proposed legislation is enacted. We welcome the opportunity to discuss your options with you.

We invite you to read other articles in this Estate Planning Series:

This article provides an overview and summary of the matters described therein. It is not intended to be and should not be construed as legal advice on the particular subject.

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