In 1992 it became apparent that Sam Walton’s careful business succession planning, which included gifting as a major component, had accomplished some incredible things. His heirs paid no estate tax at his death, and his wife and five children became the richest individuals in America, controlling collectively an estimated $86 billon of Walmart stock. On the other hand, when Elvis Presley died in 1977 taxes and fees consumed a reported 73 percent of his $10 million estate.
What was the difference? Gifting and estate planning. Today the tax rules for estate and gift tax planning (transfer tax planning) are much more favorable to taxpayers than the rules were for Sam Walton. Sam’s gift and estate exclusion (the amount you can pass without paying tax) was $600,000 — the same exclusion today is over eight times greater. However, that may all be changing as the ball drops in Times Square on Dec. 31, 2012.
At the very end of 2010, the lame duck Congress passed the Tax Relief, Unemployment Reinsurance and Job Creation Act of 2010. With it came a great gift to American taxpayers: We were each granted the ability to gift up to $5.0 million of our estate without paying gift taxes. Beginning Jan. 1, 2013, we may lose a decade of taxpayer progress and be faced with the same set of transfer taxes that existed back in 2001. This is a current and cantankerous debate among lawmakers today and leading tax experts expect the gift exclusion amount to be slashed.
Indexing for inflation, the lifetime exemption for gift and estate taxes for 2012 is $5.12 million per individual, with a maximum tax rate of 35 percent for gifts exceeding that amount. If we go back to previous law, we will have only a $1.0 million exemption with a maximum tax rate of 55 percent. For example, an individual with a taxable estate of $3.0 million who either gifts it or dies in 2012 will have a gift or estate tax of zero. Using 2001 law that same individual will owe tax of approximately $1.1 million.
Millions of Americans have an estate large enough to be concerned about transfer taxes. Estates include the value of everything you own including equity in all real estate (home, farm, business), retirement funds, life insurance death benefit (life insurance proceeds are taxable for estate tax purposes and are assumed received immediately prior to death), company stock or units, cars, art and household furnishings. Adding these all together, it is not difficult to get to $1 million.
How does one structure affairs to avoid these confiscatory transfer taxes? The answer is by making gifts. A common myth is that gifting means giving up control. The fact is, gifting does not mean losing control; Sam Walton controlled Walmart to his death. This idea comes as a happy revelation to most people. Gifting with retained control is accomplished when assets such as cash, stocks, bonds, real estate or the family farm or business are moved by the owners to a holding company. A gift is then made by transferring the noncontrolling interest in the holding company to a special irrevocable trust set up outside the taxable estate. To complete the process, a gift tax return must be filed by the taxpayer to report the gift to the IRS.
A particularly positive outcome of gifting is that when a gift is made, not only is the present value gifted but also the future growth in value as well. In other words, once the assets are out of the estate, then regardless of what they appreciate to over ones lifetime, they are not taxable for transfer tax purposes. A properly formed irrevocable trust currently has an unlimited life, meaning that the assets of the trust will escape the transfer taxes forever.
Current rules for gifting are five times better than they have ever been. Individuals with assets exceeding $1 million and couples with assets exceeding $2 million will do their family a huge service and preserve the family farm, business or other assets from a 55 percent estate tax haircut and will avoid having to sell assets to pay the estate tax by planning now.
As John F. Kennedy stated, “There are risks and costs to a program of action, but they are far less than the long-range risks and costs of comfortable inaction.” Doing some relatively simple and inexpensive planning saved the Walton family fortune and today proper planning for millions of Americans will save the family farm.
Rich is a certified public accountant who works in the area of dynasty estate planning, retirement and personal finance. He is also the host of "What About Wealth?" on Voice America Radio.