With the expected large increase in gift and estate tax rates for 2011, December 31, 2010 is the key date to make any large taxable gifts.
Currently, the maximum gift tax rate is 35% and it will rise on January 1, 2011 to 55%. There is no estate tax for 2010, but in 2011, the maximum rate will also be 55%. In other words, December 31, 2010, ironically, is the "drop-dead date" for taking advantage of the 35% rate. Basically, gift taxes are on sale for 2010 only.
If the farmer dies in 2010 after making a taxable gift, then paying the sales price - the 35% gift tax - will have backfired since there are no estate taxes owed for 2010. That is why any farmer will want to wait until December 31, 2010 to consider making these gifts.
Another potential draw back to the gift in 2010 is that if the farmer dies within 3 years of making the gift, it is basically undone and the gift and gift tax paid is included in the farmer's estate and taxed at whatever rates are in effect at that time. The farmer would not be any worse or better off from dying within this 3 year period, but the benefit of making the gift in 2010 would be nullified.
For example, let's assume we have a farmer worth $10 million and elects to make a gift on December 31, 2010 of $4 million. They will pay a gift tax of about $1.4 million. After paying this tax, they have reduced their estate from $10 million to $4.6 million. Assuming the farmer lives for at least 3 years, the estate will only pay tax on the $4.6 million at 55% or about $2.5 million of total estate tax. This tax plus the $1.4 million gift tax equals total taxes of about $3.9 million. They were able to pass on to theirs heirs $6.1 million.
Now let's assume the farmer does not live three years or does not make the gift. They will be taxed on the full $10 million at 55% or $5.5 million of total estate tax. Their heirs only recieve $4.5 million instead of $6.1 million. By making the gift on December 31, 2010, the family saved $1.6 million of estate taxes or about 30%.
This strategy is primarily focused on the farmer who has a net worth greater than $5 million, the liquidity to pay the gift tax and is probably in their 70's or 80's.
A major caveat is that Congress may make changes to the 2011 estate law before December 31, 2010, however, it makes sense to at least plan for reviewing this strategy with your tax advisor if Congress does not act in time.
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