How to Smartly Give Away Assets in Your Lifetime

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Benjamin Franklin once quipped, “In this world nothing can be said to be certain, except death and taxes.” The wise man’s words couldn’t ring more true today, as we approach the end of 2012. For many, the end of this particular year may have significant estate tax ramifications. Unless Congress acts before the end of the year, on January 1st of 2013 the current set of very favorable laws governing the transfer of assets enacted in the “Tax Relief Act of 2010” will no longer be in existence.

But fret not, the duration of 2012 still offers many an unprecedented opportunity to remove assets from estates through gifting strategies that can help reduce estate taxes and provide loved ones with a more substantial legacy.

If you want to engage in a lifetime of prudent gifting, you really should make sure you are properly educated and aware of certain important rules. For instance, at the end of 2012, the lifetime gift tax exemption of $5,120,000 per person is scheduled to go back down to $1,000,000 and the highest marginal federal estate tax rate of 35% will revert back to 55%.

Currently, you can make gifts of up to $13,0001 per person ($26,000 for married couples) to as many and anyone you desire without triggering any tax consequences. Be cautious though- if you gift more than the $13,000 allowed to any one person, such amount will be applied toward your lifetime gift tax exemption. In addition to the ideas discussed above, for those still looking for additional ways to transfer wealth, you may want to consider some further techniques.

A Charitable Remainder Trust (CRT) is a tax-exempt way to distribute income from the trust to beneficiaries for a period of time after which the remaining assets are distributed to your charities of choice. You determine the time frame of the trust— it can last a lifetime or for a fixed term of up to 20 years— as well as the amount of annual payouts. First off, the annual payout for the length of the trust or the life expectancies of the beneficiaries (which would be you or your spouse) cannot exceed 50% or be less than 5% of the value of the trust. And a private foundation or donor-advised fund may be named as the charitable remainder beneficiary.

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Highly-appreciated assets owned by the trust can also be sold without an immediate capital gain, which may allow for an increase in current income as well as income tax deduction. However, the type of assets gifted and the type of charity receiving the gifts, as well as your adjusted gross income, are all taken into consideration in determining your charitable income tax deduction. What’s more, there may be income tax due on your annual payouts from the trust.

A Charitable Lead Trust (CLT) is funded with assets that are, preferably, expected to appreciate. The charity of your choice receives a fixed annual payout from the trust, and the remainder goes to your family members at the end of the charity’s payout term.

Unlike charitable remainder trusts, charitable lead trusts are not tax-exempt. However, tax implications differ between a grantor CLT and a non-grantor CLT. With a grantor CLT, you are treated as the trust’s owner for income tax purposes and are responsible for paying taxes on the income generated. However, there is the potential to receive an immediate charitable income tax deduction for a portion of your contribution to the CLT. In the case of a non-grantor CLT, on the other hand, no upfront charitable deduction is allowed for income tax purposes. However, the CLT itself receives a charitable income tax deduction each year for the qualifying distribution it makes to charity. The primary benefit of a CLT lies in its potential gift-tax advantages. The value of the donor’s initial gift to the trust is determined by three factors: a government-set interest rate, the length of the trust and the payout to charity. When the government-set interest rate is low, the value of the donor’s gift is reduced for gift tax purposes. So CLTs are particularly attractive in periods of low interest rates.

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A Grantor Retained Annuity Trust (GRAT) allows you to pass assets you believe will appreciate in value to family members at discounted levels. You contribute assets to a trust and receive a fixed annuity payment stream for a specified period of years. At the end of the trust term, the remaining assets and their appreciation (if any) are distributed to your beneficiaries. Since the value of the gift is reduced by the present value of the annuity payments, you could structure a payment schedule and payout amount that could result in a minimal gift-tax value. However, if you die before the end of the specified term, some or all of the remaining trust property would be included in your estate and subject to estate taxes.

Life Insurance can help meet your estate and gift tax liabilities. Life insurance often provides a substantial benefit for relatively small costs. A life insurance policy may be used by itself to increase the size of your estate, or it may be used for cost-effectively paying estate taxes. Plus, the proceeds of life insurance are typically income-tax free to the beneficiary. And with careful planning, these proceeds may also be received estate-tax free.

A Limited Liability Company (LLC) or Family Limited Partnership (FLP) may help reduce the size of your estate for transfer-tax purposes. The LLC or FLP is made up of managing or voting interests and nonvoting interests, and you could gift the nonvoting interests to your children and grandchildren. Since the non-voting interests gifted to your children and grandchildren2 lack voting rights and are not readily marketable, they might be discounted for gift tax valuation purposes.

A Dynasty Trust could allow you to establish a source of funds for multiple generations. Here’s how it generally works: You would fund the trust with an amount up to your and your spouse’s lifetime gift tax exclusions. The trust assets, including any growth, will remain free of federal transfer taxes (i.e., estate, gift and generation-skipping transfer taxes) for as long as they remain in the trust. In certain states, such as South Dakota, the trust may theoretically last forever. And the plan could be designed so that any distribution from the Dynasty Trust would be free of gift- and generation-skipping transfer taxes.

Income or principal from the trust may be distributed to your children, grandchildren and great grandchildren as specified in the trust document. The provisions could tie those distributions to incentives, such as maintaining gainful employment, and permit distributions for funding businesses or purchasing homes for the use of beneficiaries or other activities. There also may be provisions in the trust document to gift a percentage of the assets directly to a charity or family foundation. Assets remaining in the trust are protected from creditors and divorce judgments.

Create Your Estate Plan

Discuss your estate planning objectives and concerns with your financial advisor and your tax and legal advisors. Together, you can develop an estate plan that best addresses your financial and familial situations.

Insurance products are offered in conjunction with Morgan Stanley Smith Barney’s licensed insurance agency affiliates Article by McGraw Hill and provided courtesy of Morgan Stanley Wealth Management Financial Advisor.

The author(s) are not employees of Morgan Stanley Smith Barney LLC (“MSSB”). The opinions expressed by the authors are solely their own and do not necessarily reflect those of MSSB. The information and data in the article or publication has been obtained from sources outside of MSSB and MSSB makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of MSSB. Neither the information provided nor any opinion expressed constitutes a solicitation by MSSB with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.

Morgan Stanley Smith Barney Financial Advisor(s) engaged Celebrated Living to feature this article.

Adam E. Carlin may only transact business in states where he is registered or excluded or exempted from registration carlin/. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Adam E. Carlin is not registered or excluded or exempt from registration.

Morgan Stanley Smith Barney LLC and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor and for matters involving taxation and tax planning and their attorney for matters involving trusts, estate planning, charitable giving, philanthropic planning or other legal matters.

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Adam E. Carlin

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