Planning for the terminally ill in 2012

In today’s tax environment, with transfer taxes as well as income and capital gains taxes slated to rise substantially next year, planning for the terminally ill could yield large savings for surviving family members.  John J. Scroggin a noted author and planning expert outlines the unique planning possibilities that arise this year in planning for the terminally ill.   This article is from one of three from John’s series for planning for the terminally ill.

Clients who will pass after 2012. If the client is expected to pass after 2012, there are many tax planning opportunities and traps that need to be considered, including:

Estate tax clawback on gifts.  Clawback is essentially the question of whether a client who makes nontaxable gifts before 2013 will pay a transfer tax on those gifts when the client dies after 2012. There is significant disagreement among commentators on whether current law would eliminate the potential for clawback. There is general consensus that Congress will fix the issue in new legislation, particularly if the IRS acts aggressively to impose estate taxes on previously nontaxable gifts. While there are current proposals designed to mitigate the impact of clawback (e.g., H.R. 3467), there is no certainty on whether anything will be passed and, if something does pass, what the form of the new legislation will be.

Making taxable gifts in 2012. One of the issues which affluent clients should address is whether to take advantage of the lower transfer tax rate of 35% in 2012 or wait to see what the transfer tax will be when they die. While the normal advice is to defer transfer taxes as long as possible, the potential 20% swing in transfer tax rates, the low Code Sec. 7520 rates, and the increasing value of assets as we move out of the recession (and possibility into inflation) all encourage affluent clients to consider incurring taxable gifts in 2012. This is particularly true for a client with a limited life expectancy.

Illustration: Assume an unmarried widow has a $10 million taxable estate. She has an adequate pension and social security income stream to properly support her. She is expected to pass soon after 2012. Assume she made a net gift (see discussion below) of her entire estate in 2012. The gift tax paid by the donees would be $1.3 million. If she passed within three years of the gift, the gift taxes will be pulled back into her taxable estate and be paid by the donees.


Prepaying transfer taxes not only provides for potentially lower effective transfer tax rates, it also moves future appreciation on the asset outside the donor’s taxable estate and, if the donor survives the gift by three years, removes the amount of the gift tax from the taxable estate. As we move out of the recession and values start increasing (whether because of inflation or true value increases), the elimination of estate taxes on future appreciation could be a significant issue.

Hoarding cash. One of the reasons that 2012 gift planning should start early is the need for many clients to start hoarding cash or otherwise obtain liquidity to pay for any gift taxes which will be due on Apr. 15, 2013. The amount of cash the client can accumulate by Apr. 15, 2013 may directly determine how much they can gift in 2012.

Illustration: Assume an unmarried client owns a family business worth $40 million. Assume a 40% discount is applied to the gift of a minority interest in the business. He wants to pass 49% of the business to children working in the company, effectively at a taxable value of $11.8 million. If the client has all of his gift exemption available, he would need to hoard about $2.4 million to pay the gift taxes. The less cash he expects to be able to accumulate by Apr. 15, 2013, the less he should gift before the end of 2012. Assuming no growth in the value of the company and 100% is transferred at death, the estate tax savings on the 49% transfer could be $10.8 million (i.e., $40 million multiplied times 49% times a 55% tax rate, with no discount applied). If the donor survives the gift by three years (i.e., the gift taxes paid are not included in the taxable estate), there is an additional tax savings from removing the $2.4 million in gift taxes from the taxable estate.


Portability—use it or potentially lose it? A married client passes before 2013 and fails to use all of his or her available federal estate tax exemption. The unused part of the exemption carries over to the surviving spouse. As noted previously in this article, even if portability is reinstated after 2012, it is unclear how it will be calculated. Affluent clients should consider using not only their own gift tax exemption in 2012, but also any portable exemption of a predeceased spouse. Better to use the available portable exemption in 2012 than risk losing it in 2013.

Illustration: A surviving husband has a $20 million estate and has not used any of his gift exemption. His wife died in 2011 and did not use $3 million of her estate exemption. If the husband gifted $8 million to his descendants in 2012, the transfer would save his descendants up to $3.85 million (i.e., $7 million times 55%) in estate taxes (ignoring any appreciation).