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Eastman & Smith Alert: Year-end Gifting to Reduce Estate Taxes

12/9/10

With the estate tax exemption dropping to $1 million in 2011 unless Congress acts by year-end, annual exclusion gifts in 2010 (up to $13,000/donee, or $26,000/donee from a married couple who elects to split gifts) are an especially attractive way to reduce the donors estate.

Gifts qualify for the annual exclusion only if they are gifts of a present interest. This is the case only if the donee has unrestricted access to the gift (i.e., an outright gift), or, in the case of gifts to an irrevocable life insurance trust (ILIT) or other irrevocable trust, if the donee has a limited right of withdrawal (a Crummey power).

Annual exclusion gifts can be a powerful estate tax savings tool. If, for example, a 48-year-old couple gifted $26,000 to each of their three children for 30 years, and the gifted funds grew at 5% per year, the gifts invested over 30 years would grow to $5,182,230 outside the couple's estates, and the federal estate tax savings at the current rate of 45% would be $2,332,004. Alternatively, the tax-free transfer of wealth can be dramatically magnified by gifting to children or an ILIT to purchase life insurance outside the insured's estate.

This also may be an appropriate time to gift assets that are currently depressed in value because of the economic crises, but are likely to rebound in the future. Such discounted gifts can leverage the gift tax annual exclusion and further increase the tax-free transfer of wealth over time.

2010 is also an attractive year for gifts by donors who have already exhausted their $1 million lifetime exemptions, since the gift tax rate is only 35% (vs. at least 41% in 2011 if Congress does not act). Since the gift tax is only on the net amount transferred (instead of on the gross amount involved, as with the estate tax), the effective gift tax rate is only 25.9%.

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