The 'generation-skipping' tax is set to expire for a year, along with the estate tax. Gifts from grandparents will be taxed at 35% instead of three separate taxes, each higher
By Ryan J. Donmoyer and Margaret Collins
(Bloomberg) — Wealthy individuals who give their fortunes to grandchildren will see taxes on those gifts drop to 35 percent due to the expiration of the estate tax on Jan. 1.
Current levies on gifts to grandchildren or later generations, known as the generation-skipping tax, are scheduled to expire for one year along with the federal estate tax because Congress abandoned efforts to extend both last week.
That means individuals may transfer assets next year to younger generations and pay a single 35 percent gift tax, compared with three sets of taxes each as high as 45 percent. Higher taxes return in 2011 unless Congress acts sooner.
"It's been prohibitive for making direct gifts to grandchildren," said Neil Tendler, a tax principal in the Family Office Group at Rothstein Kass based in Roseland, New Jersey, of the expiring taxes.
The opportunity to transfer wealth at a steep tax discount has left lawmakers and estate planners trying to deal with the consequences of the law expiring, said Carol Harrington, head of the personal wealth division at the Chicago law firm McDermott Will & Emery LLP. Those who make gifts early in 2010 may find they owe additional taxes if Congress makes the law retroactive as some lawmakers have said they'll do.
"There are some people who will take that bet" that Congress won't act, Harrington said. "It could be a pretty big advantage if Congress is so dysfunctional that retroactivity is no better than a 50-50 bet."
The generation-skipping tax originally was designed to prevent the wealthy from avoiding taxes when they die, the Congressional Budget Office said in a report to lawmakers Dec. 18. The total tax on gifts to grandchildren have been so high that very few estates have made such transfers, according to the report.
Under current law a gift of $10 million to a grandchild would face total taxes of about $8 million, including available exemptions, said Matt Brady, head of the Wealth Advisory group of Barclays Wealth in the Americas. The same gift will be taxed in 2010 at a rate of 35 percent, or about $3.5 million. In cases where no more exemptions are available, the total tax may be worth more than the gift itself, Harrington said.
If Congress extends the taxes retroactively, there likely will be lawsuits challenging their constitutionality, although a 1994 Supreme Court case allowed some retroactive taxes, said Tom Karsten, senior managing partner at Karsten Tax and Financial Management based in Fort Worth, Texas.
Senate Finance Committee Chairman Max Baucus, a Democrat from Montana, and Charles Rangel, chairman of the tax-writing House Ways and Means Committee and a Democrat from New York, said they are working to extend the estate and generation skipping tax in 2010.
The House of Representatives adopted legislation Dec. 3 to make the current estate and generation skipping tax rates permanent. The House is adjourned until Jan. 12. In the Senate, 11 Democrats earlier this year backed all 40 Republicans in seeking a lower 35 percent rate on estates valued at more than $10 million per couple.
Clint Stretch, a principal at the Washington consulting firm Deloitte Tax LLC, said promises by legislators to act in January probably won't be kept.
"History would say they don't get their act together that quickly," Stretch said. "I could easily see a scenario where addressing this problem is much longer than January; it could be as long as April or May."
Karsten said the longer Congress delays, the longer the odds of a retroactive reinstatement.
"The longer it goes on the greater potential that Democrats could say we don't need to fix it," he said. "In an election year they can say: 'we didn't pass this legislation, this was passed during the Bush administration.'"
To contact the reporters on this story: Ryan J. Donmoyer in Washington at firstname.lastname@example.org. Margaret Collins in New York at email@example.com.