A special power of appointment typically means that the grantor has special powers in the trust that do not affect its asset protection benefits. A special limited power of appointment is considered a grantor trust, which does not need to pay income taxes. The income flows through the trust to the grantors, or the husband and wife. They would pay taxes on trust income at the lower individual income tax rate rather than trust rates. In essence, the husband and wife would pay the same income tax that they paid prior to establishing the trust.

Potential Capital Gains Benefits

The estate inclusion also provides a significant tax benefit known as a step-up in basis for capital gains tax purposes. If a parent transfers an asset that has increased in value, the parent’s cost basis carries over to the child. That means, when the asset is eventually sold, the child will be assumed to have taken the asset at the same price as the parents and required to pay capitals gains taxes on the full increase in value. In our example with the Massachusetts couple, if the parents obtained their stock at $100,000 and transferred it as a gift to the children with a value of $500,000, the children are given a cost basis of $100,000. If they later sell the stock for $500,000, the children will realize and recognize a $400,000 capital gain, which translates to approximately $100,000 in federal capital gains tax liability.

Instead, if the parents transferred the stock to an irrevocable trust, the stock would be includible in the gross estate of the parents and given only a step-up in basis. The step-up in basis means the stock is valued as of the date of the parent’s death, not the time of purchase. If our parents put their home into an irrevocable trust with a fair market value of $500,000, the children’s cost basis is $500,000. Therefore, if the children sold the home soon after their parents’ deaths, there would be little or no capital gains to be taxed. As far as the children are concerned, this is a much more desirable outcome. This benefit is not available to individuals who transfer assets to their children as gifts.

In conclusion, the UltraTrust type of irrevocable trust is the only type of trust that allows parents to transfer assets in a manner that will provide protection from their creditors, including the costs of long-term care, and their children’s creditors (including ex-spouses) while allowing the parents to benefit from the assets comprising the trust during their lives. In addition, this trust provides some estate and income tax benefits for both the parents and their heirs. Therefore, the irrevocable trust is about as close as a couple can come to having their cake and eating it, too.

The estate tax and gift tax exclusions are at an all-time high at $5.12 million but only till the end of 2012. Plan your tax season with a LLC and an UltraTrust irrevocable trust because there may not be another opportunity after 2013.

Put simply, if you don’t act now, you will throw away at least half of every dollar in assets you have over 1 million.

Now is the Time to Make Gifts to Benefit from the Estate Tax and Gift Tax Exclusion Amounts

While asset values remain low due to current economic conditions. This combination of a high exclusion amount and a depressed economy provides an opportunity to shift a greater amount of wealth at a lower cost since the tax liability on transferred assets is assessed on the fair market value at the time of the transfer. It is imperative to take advantage of the exclusion amounts before the year is out, though, because unless new legislation is enacted, both exclusion amounts are slated to decrease back down to $1 million in 2013. Some planning options you may want to consider:

As we rang in the New Year at the beginning of 2012, the federal estate and gift tax exclusion amounts increased to a historically high level of $5.12 million dollars ($10.24 million for married couples).

You may want to consider making gifts, and even taxable gifts, during 2012 as the current gift tax exclusion and tax rates may not be extended. The lifetime gift tax exclusion amount is set to decrease to $1 million in 2013. Furthermore, the maximum gift tax rate during 2012 is only 35%, compared to the top rate of 55% in 2013 (see chart below). So, not only can you transfer a significant amount of assets (and any future appreciation) out of your taxable estate before incurring gift tax, but you can gift in excess of your available exemption amount and incur a much lower rate of tax.

How do I make these Gifts?

If you are like most people, you shudder at the thought of giving a large sum of money and assets to your children, grandchildren or other individuals. Furthermore, you may own business entities in which you still wish to remain involved. Estate Street Partners recommends a combination of Limited Liability Companies and the Ultra Trust® irrevocable trust in order to take advantage of tax savings, safeguard the assets from family temptation, and continue to grow the assets in the manner in which you are accustomed. Estate Street Partners has over 10 years of experience, the financial expertise and tried and true

Sales to an Ultra Trust® Irrevocable Trust

Using a sale to an Ultra Trust® can be an effective way to reduce your taxable estate and better protect assets for future generations. 2012 may be the best year to initiate this type of planning, especially in light of the new fiscal policies being proposed by the Obama administration for fiscal year 2013 (discussed in further detail below).

In an Ultra Trust® transaction, assets (typically LLC interests) are sold to an Ultra Trust® for fair market value in exchange for an installment note. At the end of the note’s term, the assets remain in trust for the trust beneficiaries and are outside of the estate of the seller. An Ultra Trust® generally requires a “seed” gift to fund the trust of at least 10 percent of the value of the assets that will be sold to the Ultra Trust®, and this gift may be subject to gift tax. But as I explained earlier, this is the highest gift tax exclusion year on record.

With the higher exemption amounts, not only can a greater amount be gifted to these types of trusts in 2012, but the gift tax on these gifts may be significantly reduced, or even eliminated.

Discount Planning with Limited Liability Companies (“LLC”)

Many individuals or families establish a limited liability company to centrally hold and manage their assets, receiving LLC interests in return for their contributions. If you have established an LLC, or are considering establishing an LLC, another tool to reduce your taxable estate is to gift LLC interests to your children, grandchildren or trusts established for their benefit. With asset values already low, LLC interests may be discounted in value even further due to lack of marketability or minority interest discounts. Gifting LLC interests rather than gifting the underlying assets may also allow an individual to maintain oversight over the underlying assets.

Looking Ahead to 2013 – the President’s “Green Book” budget proposals and the impact on Federal Transfer Taxes

On February 13, 2012, Congress began reviewing the President’s budget proposals for fiscal year 2013 (commonly known as the “Green Book”), including a proposal that would alter the benefits of planning with intentionally defective grantor trusts (“IDGT”) like the Ultra Trust®.

Selling assets to an Ultra Trust® is a popular way to reduce your taxable estate and it can be extremely beneficial, both from a transfer tax and an income tax perspective. An Ultra Trust® is structured so that the grantor is treated as the owner of the trust for income tax purposes, but not for transfer tax purposes. Accordingly, gain or loss on the sale of assets to the trust is not recognized, but the assets (including any appreciation) are excluded from the grantor’s estate upon death. The trust is “defective” in that it intentionally gives the grantor certain powers that cause the grantor to still be treated as the owner of the trust for income tax purposes. The grantor continues to pay the income taxes on the trust’s income, further depleting his or her estate. As discussed earlier, this planning technique can result in a significant transfer of wealth while minimizing the tax consequences.

The new proposals for 2013 seek to “coordinate income and transfer tax rules” that relate to grantor trusts, thereby completely removing the advantages of using grantor trusts, and in particular, planning with sales to an Ultra Trust®. In general, the proposal provides:

• An Ultra Trust® would be treated as a grantor trust for transfer tax purposes, meaning that the assets of the Ultra Trust® would be included in the grantor’s gross estate for estate tax purposes upon death;
• Any distributions from the Ultra Trust® during the grantor’s lifetime would be subject to gift tax; and
• trust assets in the Ultra Trust® would be subject to gift tax during the grantor’s lifetime if the Ultra Trust® ceases to be a grantor trust at any time.

The proposal would be effective only for those trusts established after the date of enactment, so the Ultra Trust® remains a powerful planning technique to consider for this year.

Other relevant proposals being advanced by the Administration include:

• Returning the estate and generation-skipping transfer tax exemptions to $3.5 million, and the gift tax exemption amount to $1 million, with a top tax rate of 45%;
• Making portability of unused exemption amounts between spouses permanent;
• Requiring basis consistency for transfer tax and income tax purposes;
• Requiring a 10-year minimum term for grantor retained annuity trusts, and a maximum term of the life expectancy of the annuitant plus ten years; and
• Limiting the duration of the GST exemption to 90 years (for additions to existing trusts and trusts created after the date of enactment).

If these proposals are enacted to take effect in 2013, it may be just that more important to consider implementing planning this year before certain tax advantages are gone.

Highest U.S. Estate Tax Exemption About to Expire

In several weeks, the unprecedented increase in the U.S. estate tax exemption amount is scheduled to expire. This increase presents an unique opportunity to transfer significant wealth tax-free. The decision whether to take advantage of this opportunity will have far flung effects into the future and ultimately will influence how your assets will be shared between your heirs and the U.S. government.

It typically takes at least three months to complete a well thought-out wealth transfer plan once a decision has been made to transfer some of your accumulated wealth. As only three months remain within this year and three months are needed to properly implement a wealth transfer plan, the window of opportunity to consider and take advantage of this unique tax-free wealth transfer period of time is towards its end.