Donor's Remorse

Now that 2010 finally ended and Congress finally acted with respect to the estate and gift tax, a lot of gift and estate tax lawyers and their clients are trying to figure out how to reverse taxable gifts they made in 2010. It's a classic case of "it seemed like a good idea at the time." And it did.

This was the situation: In 2010 there was no estate tax. It was scheduled to return in 2011, but with only a $1 million exemption, as opposed to the $3.5 million exemption that existed in 2009, and at a 55% tax rate. To avoid a 55% tax on estates over the $1 million exemption, many estate and gift tax lawyers advised their clients to make taxable gifts in 2010. The reasoning was, the gift tax is only 35%. Better to save 20% in taxes by making a gift now than risking dying in 2011 or after.

But in January, Congress amended the tax code to provide for a $5 million exemption ($10 million for couples) and imposed only a 35% tax rate. Now, many of those people who made taxable gifts last year are realizing that they could have avoided any tax simply by waiting. For those with estates between $1 million and $5 million, this is certainly true. So they and their attorneys are scrambling to see if there is a way to undo the gifts they made last year.

This is a classic case of people ignoring the sage advice my tax professor gave in law school: Never do anything solely for the tax consequences. Do something that makes sense from a business standpoint and deal with the tax issue at that time. The people who made taxable gifts in 2010 did so solely in hopes of avoiding a possible estate tax.

Last Minute Tax Planning

This is the time of year that many people start last-minute tax planning. This year, because the estate tax was repealed for 2010 and the gift tax was reduced to 35%, last minute planning is even more important, and may really be last minute. There is a lot of uncertainty about whether Congress will retroactively reinstate the estate tax for 2010 and retroactively increase the gift tax to the scheduled 55% that will be imposed on January 1, 2011. While we don't recommend that anyone die before December 31 just to take advantage of the lack of an estate tax in 2010, gift planning should be considered.

Everyone can give up to $13,000 tax free to any other person, and the number of people to whom you can give $13,000 is not limited. Beyond that, if you want to give more to a single person, you have a $1 million lifetime exemption that was formerly tied to the estate tax exemption. To the extent you use the lifetime exemption for gifts, it isn't available to reduce the estate tax. If you choose not to use the lifetime exemption, gifts in excess of $13,000 are taxed at 35%. However, if the gift tax bumps up to 55% as scheduled on January 1, and especially if the estate tax exemption is lowered to $1 million, also as scheduled, it might make sense to give gifts this year and pay the 35% tax as opposed to using any part of the lifetime exemption or paying the 55% tax rate next year.

The prudent thing seems to be to plan for some gifts, but not actually make them until late December when Congress has adjourned for the year and any retroactive legislation might be a little clearer. Then consult with your tax professional.