Gifting on the rise as rich look to duck estate tax

The 84-year-old widow gathered her children at the Chicago offices of the law firm McDermott Will & Emery LLP and told them that they were going to get a special Christmas gift this year: half her $20 million fortune.

Her decision to pass on her money while still alive was prompted by the deadlock in Congress over renewing Bush-era tax cuts that could make providing for her heirs much more costly if she dies after Dec. 31.

“She said, “I don’t want anyone wishing I was dead,’” said her lawyer, Domingo Such, who declined to identify the client.

Estates are exempt from federal taxes for this year, but the rate shoots up to 55% in 2011 unless lawmakers act in a postelection session. That means that the best tax reduction strategy, short of dying in 2010, may be to transfer assets to family members this year and lock in a historically low gift tax rate of 35%.

At first, the widow’s heirs thought that she was joking about her fear of a death wish, Mr. Such said. The repeal of the estate tax this year — which the economist Paul Krugman called the “Throw Mama from the Train” law in his New York Times column — has generated much black humor about unfortunate accidents befalling wealthy parents as Dec. 31 approaches.

Mr. Such said that his client made a bet that she would reduce her tax bill by as much as 40% by rewarding her heirs immediately, compared with what she would pay if she died in 2011 or beyond. The gift tax also is scheduled to rise to 55% on Jan. 1 without congressional intervention.

‘LOWEST RATE’

“This is the lowest rate that the gift tax has ever been at; it’s only going to get higher,” Mr. Such said.

Gift taxes have long been matched with estate taxes to prevent the wealthiest from ducking the Internal Revenue Service after death. Americans can give away a total of $13,000 this year without any tax consequence, up to a $1 million lifetime maximum.

When the allowance is spent, gifts are taxed at the same rate as estates. The exception: the 0% estate tax rate prevailing this year, which is accompanied by a 35% gift tax, equal to the top marginal rate on ordinary income.

All those rates were set in 2001 as part of an effort by President George W. Bush and his Republican allies to abolish the estate tax permanently. After encountering opposition from congressional Democrats, they had to settle for a gradual reduction over a decade, culminating in a one-year repeal for this year.

Now Congress is sparring over what to do with the estate tax as part of a larger debate over Mr. Bush’s tax cuts, all of which expire at the end of the year. Democrats last month postponed any discussion on extending the cuts until at least mid-November, after the congressional elections and before most of the newly elected lawmakers are seated.

President Barack Obama and House Democrats still want to restore 2009 rules that exempted the first $7 million of a couple’s estate from any tax and applied a 45% ceiling to the remainder. Most Republicans still back extending the repeal.

In the Senate, Arizona Republican Jon Kyl and Arkansas Democrat Blanche Lincoln have attracted support from both parties by proposing a 35% rate and a $10 million exemption.

Despite the publicity around the deaths of five billionaires this year, including New York Yankees owner George Steinbrenner, lawmakers have made little progress on fixing the estate tax for next year and beyond. The five men left behind fortunes exempt from taxation.

Senate Finance Committee Chairman Max Baucus, D-Mont., vowed in December to reinstate the estate tax retroactively for this year. Tax experts said that they don’t expect him to be able to make good on that promise.

That is prompting more people to look at the relatively low current gift tax rate in their estate planning, said attorney Linda Hirschson, a shareholder at Greenberg Traurig LLP.

“People are doing planning and operating on the assumption we’re really not going to have an estate tax” this year, she said.

Wealthy people in poor health also have to consider whether they are likely to die within three years of making the gift, in which case special tax rules will cut any savings in half, Mr. Such said.

Joshua Rubenstein, head of the estate and trust practice at Katten Muchin Rosenman LLP, said that clients are all hedging their bets by waiting until late December to transfer wealth as gifts to children and grandchildren. That is to ensure that the giver doesn’t die before year-end, in which case the gift tax will have been needlessly paid.

“This is going to be the craziest year-end ever,” Mr. Rubenstein said.