Complications in Preparing 2011 Tax Returns

Preparing 2011 individual tax returns may not be as easy as people think.  To maximize tax savings, it is best to speak with a tax adviser right away before tax returns are due.  For example, an increase of the gift tax exemption from $1 million to $5.12 million inclusive of inflation creates opportunities for individuals to make direct gifts, either to designated beneficiaries or to trusts for beneficiaries’ benefit.

With the continuing poor economic conditions, many people are still unemployed after several years of job search.  Many assets are at historic lows in terms of value.  Home refinancing has gone down to 4%, and many individuals are still filing bankruptcy.  The low value of assets has the effect of gifted assets being outside of the donor’s taxable estate.  All appreciation and income attributable to the gifted assets will escape estate taxation.

For instance, an individual making a $5.12 million gift this 2012 and passing away 20 years from today, the value of the gifted assets may rise to over $9 million assuming 3 percent annual growth. If the recipients are in lower income tax brackets, the gifting may result in income tax savings. The gifted assets will avoid New York estate tax.  There is no gift tax in New York.  In most situations, the New York estate tax is calculated on the basis of assets owned at death without accounting for gifts.

In New York, for married people reluctant to lose the benefit of gifted assets, one spouse can gift to a trust for the benefit of the other spouse and children. For example, a husband gift to a trust for the benefit of a wife and children and the wife can gift assets to a non-identical trust for the benefit of the husband and children. The trusts cannot be identical in form.  The IRS has held that if two people create identical trusts for each other, the trusts are not regarded for tax reasons. With differences in the two trusts, a married couple can create trusts for each other to remove the gifted assets from taxable estates while maintaining access to the trust assets. This results in flexibility in the use of the gifted assets and the income generated by the assets.

Another concern in preparing 2011 tax returns relates to how to deal with life insurance policies.  Life insurance policies can be used to deliver wealth transfer tax savings. New Yorkers can use a part of the increased exemption by gifting cash to an irrevocable insurance trust.  Then obtain life insurance to pass estate and GST tax-free. With uncertainty in estate tax legislation, it may be prudent to buy life insurance to create liquidity to pay possible estate taxes at death. Use gifted assets to fund the insurance buy.  This may be a good investment by the recipient and a method to accomplish estate and GST tax leveraging.

For questions on individual tax concerns, consult with an experienced New York tax attorney.