Bloomberg recently reported that in January 1999, a trust set up by Mitt Romney for his children and grandchildren reaped a 1,000 percent return on the sale of shares in Internet advertising firm DoubleClick Inc. Romney avoided gift and estate taxes by using a type of generation-skipping trust known to tax planners by the nickname “I Dig It.”
These vehicles are not only for the wealthiest. Romney’s vehicle is known as an “intentionally defective grantor trust” or by the acronym IDGT—hence the nickname: “I Dig It.” Such trusts permit donors to give potentially unlimited amounts to children free of estate and gift taxes.
Here’s how it works.
You set up the trust, like Romney, in which you contribute assets such as an interest in a fund or shares in a company. The gift is based on the fair market value of the assets at the time of the gift. If you make the contribution to the trust before those assets appreciate—particularly when they are privately held and difficult to value—your gift tax obligation is low or non-existent since the value on the date of the gift is low or zero.
If the trust generates any income—such as by selling stock, like in the Romney trust—the income tax bill is the responsibility of donor (Romney in this example), not the trust. By paying the capital gains tax, which was 20 percent in the late 1990s and is now 15 percent, you can avoid depleting the funds in the trust—in essence making an additional donation that’s free of gift taxes.
This is a very effective, common strategy for how we transfer wealth to our children and avoid estate and gift tax. For 2012, the estate and gift tax exemption amount (amount excluded) is $5 million. Since we are uncertain as to where this limit will be next year, it is a great time to consider these types of gifting strategies.
We are not certain what will happen with estate and gift tax in 2013 and beyond, but based on the Mitt Romney’s effective use of these tools we would speculate that the rules would remain beneficial if he becomes President.
If you have any questions regarding estate and gift tax strategies, please do not hesitate to contact us.