The end of 2010 brings unique opportunities and problems relating to gifting. There is a strong interest in making gifts in 2010 since the maximum federal gift tax rate is 35%, and generation-skipping taxes do not apply. Absent a change in the law, come January 1, 2011 the maximum federal gift tax rate will increase to 55%, and generation-skipping taxes (at 55%) are again in effect.
Therefore, in many circumstances it may make sense to make a gift in 2010 to take advantage of the lower rate. However, there are some important considerations in undertaking such planning.
First, in many circumstances it is desirable to delay the gifts until as close as possible to (but before) January 1, 2011. This is because if the transferor dies in 2010 there will be no estate tax. Therefore, death allows for a tax-free transfer (if the gift recipient would also be the recipient at the transferor’s death), while a taxable gift incurs up to a 35% gift tax. To avoid an unnecessary gift tax, the gift should be delayed to as close as possible to the end of the year to avoid the situation of the gift being made and then the transferor dying in 2010. Also, deferring the gift will allow for consideration of any changes that may occur in the law prior to January 1, 2011 that may impact on the tax planning.
Second, if the gift involves a transfer to a trust, there are some uncertainties regarding the application of the generation-skipping tax in future years. More particularly, if the gift in 2010 is effectively a "direct skip" because it is a transfer to a trust for which all of the beneficiaries are skip beneficiaries (i.e., they are all two or more generations removed from the transferor), future distributions from that skip trust to skip beneficiaries may still incur generation-skipping tax. In normal circumstances, such a direct skip funding would change the generation levels for a generation-skipping trust. That is, if grandfather made a gift to a generation-skipping trust, as a direct skip, future distributions to grandchildren from the trust (but not great grandchildren or more remote descendents) will not be subject to generation-skipping tax. However, since generation-skipping taxes do not apply in 2010, it is unknown if this generation exemption will apply to post-2010 distributions to a grandchild from such a trust that is funded in 2010.
Further, if the transferor to a trust involved a transferor with unused generation-skipping tax exemption, there is a fair amount of uncertainty how or if to apply that exemption to the trust for purposes of computing the inclusion ratio and applicable generation-skipping taxes for future distributions out of that trust.
Third, the common understanding is that the maximum gift tax rate in 2010 is 35%. This is correct, but there are two important considerations to paying gift tax in 2010. Accelerating transfer taxes to 2010 means you are paying taxes sooner than you might otherwise. This deprives the transferor and his family unit from the ability to invest and earn from such transfer taxes. It is a maxim of tax planning that, all other things being equal, it is better to pay a tax tomorrow than today from a financial standpoint. Also, if the transferor dies within three years, estate taxes will be payable on the gift tax amount paid to the IRS. Since the maximum estate tax rate is 55% starting in 2011, the combined 35% gift tax rate and a 55% estate tax rate on gift taxes paid can result in a combined maximum rate of approximately 54%, which is barely better than the maximum 55% rate which would apply 2011 and beyond on gifts.
Therefore, it is advisable to consider making gifts in 2010, but the above considerations, among others, need to enter into the analysis.