Over the past few months, I have noted an abundance of television, radio and newspaper articles covering the issue of tax fairness. Undoubtedly, some of these articles have been prompted by the Republican presidential primary. Ignoring the political side of the story, however, they have been interesting from a tax perspective.
By example with respect to income taxation, Mitt and Ann Romney reportedly earned $21.7 million in 2010 and paid income taxes at the rate of 13.9%. Similarly, Warren Buffett reportedly had gross income in 2010 of more than $62.8 million and paid income taxes at the rate of 11.6%. As a result of the way in which this income was earned and taxed, both of these taxpayers legitimately paid considerably less than they would have paid on wages or salary, where the top marginal rates were 35% in 2010. Whether or not this system of taxation is fair to all taxpayers is a question for the legislature, and not for individual taxpayers or their advisors. Following the rules can simply lead to disparate treatment under the current law.
Comparable loopholes are available in gift and estate tax planning. Most Americans pay none of these "wealth transfer" taxes due to the current exemption of $5,120,000, and similar, albeit much smaller exemptions which have been available for many decades. Only taxpayers making lifetime or testamentary gifts in excess of the exemption have had to actually pay these taxes, currently at the rate of 35%.
Even with the gift and estate tax exemptions, however, it is possible for wealthy Americans to take advantage of additional loopholes in order to avoid or reduce gift and estate taxes. The billionaire founders of Facebook apparently used a form of irrevocable trust known as a GRAT (grantor retained annuity trust) in order to give away more than $200 million without payment of gift taxes. A GRAT is especially useful when it is funded with an asset most likely to appreciate faster than the US government's assumed interest rate, which is currently 1.4%. For the Facebook founders, the GRATs were funded with pre-IPO Facebook stock in 2008 when the stock value was minimal. All of the subsequent appreciation realized when this stock recently went public now belongs to the beneficiaries of the GRATs, without gift taxation.
Mitt and Ann Romney apparently took advantage of the annual gift tax exclusion and a number of other tax loopholes in order to fund a trust for the benefit of their children, now reported to be worth more than $100 million, also without paying any gift tax. Since trusts are generally private documents, even for politicians, the exact terms of the trust are not known. Even though this trust could have been legitimately created and funded under our current tax laws, however, it is possible that the IRS will be taking a closer look in light of the publicity which has been generated in recent months.
On a much smaller scale, many of our clients have created irrevocable trusts in order to make gifts to their children, grandchildren or other family members. These trusts are most often funded with annual exclusion gifts, and may be used to hold life insurance or other assets in a manner designed to avoid taxation in the donor's estate upon death, even when the life insurance proceeds may be significant or when the trust assets have substantially appreciated in value.
Of course, sophisticated tax planning is both complicated and expensive. The tax savings are only available if all of the rules are followed and properly documented. Accordingly, it is only undertaken when the potential tax benefits justify the cost.
If you would like to discuss whether or not sophisticated tax planning should be included in your estate plan, please schedule an appointment with Christine or me. We would be happy to discuss these issues with you.