Lars has explained to Nils the likely estate tax benefits of giving $500,000 to a trust for relatives this year. Nils is able to do this without immediate tax because the formerly $1 million gift tax exemption (the amount one may give during lifetime without paying gift tax) was increased to $5 million for 2011 and 2012. Nils had already used the $1 million exemption.
One benefit Lars has pointed out, is that future income and gain on the $500,000 will occur outside Nils's taxable estate, rather than within it. Lars has a guess on how that will work out. Nils, in his eighties, has a remaining life expectancy of only about six years (although his hardy and determined nature seems to promise more). The trust is likely to have about $200,000 of income and gain over the six years. If we figure the combined State and Federal estate tax rate will be 50% when Nils dies, then this should produce about $100,000 in savings for Nils's estate.
A second benefit under current law is that the State of Washington has no gift tax. The Federal and State taxing systems are radically different in this respect. For Federal purposes, any lifetime use of the gift tax exemption also uses estate exemption. So for example Nils's $1 million in earlier gifts meant that he started 2011 with only $4 million of the new $5 million remaining.
Contrary to this Federal concept, the State (Washington, that is) taxes only estates and not gifts. So lifetime gifts aren't counted against the (now $2 million) State exemption. The effect of this is that Nils's $500,000 gift to the trust in 2012 is likely to avoid State estate tax altogether. Of course laws can change, but a retroactive amendment would meet a Constitutional challenge.
The top State rate that would affect Nils's estate is 19%. If that holds, the gift to trust will save almost another $100,000. Nils likes that idea.
So by these calculations the 2012 gift to trust promises something like $200,000 in tax savings. As we'll see over the next couple of weeks, the benefit can be even greater than this, with the use of a couple other tax concepts.