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Gift Tax Update and Opportunities

    Client Alerts
  • November 01, 2010

While the estate and GST taxes have been repealed for 2010, the gift tax has not. However, the top gift tax rate currently is 35% (as opposed to 45% in 2009), while the gift tax exemption remains at $1 million per person. In 2011, the gift tax rates will be unified with the estate tax rates and the top rate is scheduled to be 55%. Even if legislation is passed to set the estate, GST and gift tax rates and exemption amounts as they were in effect in 2009, the gift tax rate will be 45% (10% higher than the current rate in effect). Taxpayers often find it difficult to take advantage of making a gift – either because of the emotional attachment to the asset, the reliance on income from the property or the resulting gift tax cost. However, with the confluence of current circumstances, including: (1) the potential of a reduced estate tax exemption amount of $1 million; (2) depressed asset values (as a result of the current state of the economy); (3) record low interest rates (that are a factor in certain more sophisticated gift tax planning techniques); and (4) historically low gift tax rates, this may be an appropriate time to make a significant gift.

Current Favorable Gift Tax Rate

Under prior law, the tax rates for both transfers at death and during life were unified. However, with the repeal of the estate tax for 2010, a transfer at death has no tax cost, while a taxable transfer during life (a transfer that exceeds the gift tax exemption amount of $1 million) will be taxed at 35%. It may seem counterproductive to make a taxable gift in the current year, incurring the imposition of a gift tax, when a transfer of the same asset at death may not result in an estate tax liability. This conclusion is accurate, if you assume that the estate tax will remain repealed and/or that the transferor will not otherwise be subject to the estate tax (such as by application of a higher estate tax exemption amount). However, consider a taxpayer that survives 2010 and has a taxable estate in excess of $3.5 million. For this taxpayer, making a taxable gift in 2010 will result in less net transfer taxes, which is demonstrated by the following example:

Richard has $10 million of property. He faces the current situation: the current gift tax exemption amount is $1 million, the current gift tax rate is 35%, the estate exemption amount in 2011 will be $3.5 million and the estate tax rate will be 50%. Richard is considering making a taxable gift of $3 million of property in 2010, and anticipates surviving the current year. Assuming Richard makes the gift in 2010 and dies in 2014 (and assuming no growth or depletion in asset values), the aggregate estate and gift tax paid and the net value received by his heirs if he makes the gift versus not is as follows:

2010 Estate Value $10,000,000 $10,000,000
Taxable Gift $3,000,000 -0-
Exemption Used $1,000,000 -0-
Gift Tax Paid $700,000 -0-

2014 Taxable Estate $6,300,000 $10,000,000
Available Exemption $2,500,000 $3,500,000
Net Taxable Estate $3,800,000 $6,500,000
Estate Tax Paid $1,900,000 $3,250,000

Aggregate Estate/Gift Taxes $2,600,000 $3,250,000
Net Aggregate to Heirs $7,400,000 $6,750,000
Benefit/(Detriment) $650,000 $ (650,000)

Based on the above example, for those taxpayers who likely will have a taxable estate, making current transfers and incurring gift tax at the current rate of 35% is a strategy to consider.  Additionally, there are a number of ways in which a gift can be made so as to minimize the gift tax value (and cost) and to enable the transferor to receive an income stream from the gifted property for a number of years. Some examples of this are below:


A Grantor Retained Annuity Trust (“GRAT”) can efficiently – from a gift tax perspective – transfer wealth to the next generation. By definition, a GRAT is a split interest trust that creates two separate and distinct interests in the trust’s assets: (1) the current interest, represented by the annuity payable to the grantor; and (2) the future interest, represented by the remainder that is payable to designated beneficiaries. 

Any transfer of property to a GRAT is an irrevocable transfer constituting a gift for Federal (and State, as applicable) gift tax purposes. The value of the gift is in general terms the present value of the remainder interest in the trust. The value is determined based upon (1) the fair market value of the property initially transferred to the GRAT; (2) the term of the GRAT; (3) the annuity payments to be made to the grantor of the GRAT; and (4) the applicable interest rate prescribed by the Service (the Code Section 7520 rate for the applicable month in which the GRAT is funded). Economically, if the assets transferred to the GRAT “outperform” the Section 7520 Rate, the technique should succeed in transferring wealth to the remainder beneficiaries at no additional gift tax cost. Because the current Section 7520 Rate is at an almost historically low rate (2% for the month of November 2010), implementing and funding a GRAT is particularly attractive as economists anticipate a rebound in both the stock and real estate markets in the coming years.


Similar to a GRAT, a Qualified Personal Residence Trust (QPRT) employs the same strategy, but the trust is funded with a personal residence – such as a vacation home. Again, a QPRT is an irrevocable trust with two distinct interests: (1) a current interest retained by the grantor; and (2) a remainder interest for the benefit of designated persons. During the term of the QPRT, the grantor is entitled to reside in and use the residence. At the end of the term, ownership of the residence is transferred to the designated beneficiary (or beneficiaries). With currently depressed real estate values and the current Section 7520 Rate of 2%, individuals with a family vacation home may consider implementing a QPRT.

Loans and Other Transfers in Exchange for Promissory Notes

Finally, there are a number of strategies and techniques that involve loans or sales in exchange for a promissory note. Loans are required to carry a minimum interest rate in order to avoid adverse income and gift tax consequences, but the current minimum rates are nominal – .35% for loans due within three years and 1.59% for longer term loans (between three and nine years).