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What high impact tax planning can you do in September?

September 7, 2012
by Jack Reynolds

When is the best time to review your tax and investment planning? Now! People who wait until the fourth quarter to do their year-end tax and investment planning are likely to run into a log jam. I have a radical suggestion: don’t wait for the fourth quarter this year. The time to do your most important year-end tax planning for your assets is in September.

What high impact tax planning can you do now?

The best advice I can offer you is to take advantage of the current tax law and make the biggest gifts you can comfortably afford to your children and grandchildren tax-free – even if you do not have any grandchildren. You might wonder, “How can I make a tax-free gift to my grandchildren if I do not have any grandchildren?” Learn how below.

High Impact Tax-Free Giving Limits Are Likely to Erode December 2012

In late December 2010, Congress dramatically increased your capacity to make gifts to your children and grandchildren without paying a gift or estate tax. In short, you can give $5.12 million to your children, or $10.24 million if you are a couple, tax-free until December 2012. It is important to note that these tax-free gift limits apply to the total gifts you have made over your lifetime to your children, or other non-charitable beneficiaries, apart from your annual exclusions gifts. If, for example, you are a couple and have already given $2 million to your children, you can give an additional $8.24 million tax-free between now and December 2012. This enormous tax-free giving opportunity is currently scheduled to be dramatically reduced at year-end, absent Congressional action. But that is not all.

Have Grandchildren?

If you have grandchildren or think that someday you might, then read on. If not, then please skip to the next section. When you make a taxable gift to your grandchildren you typically have to pay both a gift tax and a generation skipping tax. The combination of these two taxes is prohibitively expensive and discourages people from making generation skipping gifts (i.e., gifts that skip over your children and go to your grandchildren). Today’s generous tax-free giving limits apply to both children and grandchildren, which allows you to transfer funds to your grandchildren tax-free. For most people, this is done by setting up a generation skipping trust (GST). Overall, this significant increase in tax-free giving to children and grandchildren is a huge opportunity for families with significant means and is not to be ignored.

Beneficiary Options for Unborn Grandchildren

Suppose you do not yet have any grandchildren to whom you can make a gift. Here is another option to consider. Set up a generation skipping trust (GST) for the benefit of your unborn grandchildren and name your children as secondary beneficiaries. In the event that you do not have any grandchildren, your children will become your beneficiaries. Your attorney will help you structure this.

What Type of Gifts Can You Transfer to a Generation Skipping Trust (GST)?

If you are considering a GST for your (unborn) grandchildren, the easiest and most straightforward gift is cash or marketable securities. If you want to gift something with more impact, consider hard-to-value investment assets, e.g., an interest in a private equity fund, fund-of-funds, or an operating business. The advantage of giving hard-to-value investment assets is that they may be transferred at a discounted value – discounts of 30% are not uncommon. The sooner you begin discussing these subtle tax planning nuances – and more exotic assets – with counsel the better off you will be.

Another interesting possibility is to fund your GST with a second-to-die life insurance policy on you and your spouse (the policy pays off when you are both deceased). If this is an option for you, then it is wise to initiate the GST with sufficient resources to pay the premium on the life insurance policy. Further, be sure to work with a sophisticated life insurance professional in considering this path, as well as a qualified attorney and CPA.

How Long Should the GST Exist?

When you set up a GST you should think about how long you want the trust to exist. Most states permit trusts to last for the duration of the lives of the persons you specify, plus 21 years. Other states permit trusts to last much longer. If you want to set up a very long-term trust, you may want to consider Delaware, New Hampshire, South Dakota, Alaska, Wyoming, or other favorable jurisdictions for the location of your trust. A qualified attorney and private banker can help you evaluate your choices.

If you want a perpetual entity then you may want to consider setting up your own private trust company. However, this should be discussed with your counsel as it is not likely to make economic sense unless you are considering asset transfers of a very substantial scale.

How Much Should You Give?

At the most obvious level, you are giving away too much to your grandchildren if you are even remotely at risk of impoverishing yourself, your spouse or your children. Should you consider exceeding the limits on tax-free gifts? In some cases this makes sense as it is much more tax-efficient to pay a gift tax than an estate tax. Your attorney or CPA can walk you through the simple math more easily than I can here, but suffice it to say that the numbers are compelling.

In summary, as you address year-end tax and investment planning, it would be wise to consult with your family, investment committee, trustees and/or trusted advisers and professionals. If you would like to be referred to a suitable attorney, CPA, life insurance professional, or private banker please let me know straightaway. Your feedback on this article is valuable to me. Please share your thoughts by dropping me a note or giving me a ring at 617.945.5157. You can also rate this article, share it with a friend or leave comment below. Your comments below will be especially appreciated.