Posted
Jun 19 2008, 09:29 AM
by
Bob Carlson
The estate tax is scheduled to be eliminated in 2010 and be restored to its 2001 version in 2011. It is probable, however, that the estate tax will be changed after the 2008 elections. The most likely scenario is that a lifetime exemption in the $3 million to $5 million range will be enacted. I suspect a $3.5 million exemption and a 45% top tax rate will be the final version.
Many people put estate planning on hold and stopped making estate planning gifts when it appeared the estate tax would be eliminated. Now, those whose estates are likely to be $3.5 million or higher should consider resuming estate planning gifts.
Those with gift giving plans should pay attention to the details so they can maximize the tax benefits of gifts and avoid making the big giving mistakes many people make.
The tax goal of annual gift giving is to remove assets and their future appreciation from the estate. Estate and gift taxes are imposed on the value of assets. The lower the value of assets in the estate, the lower will be the taxes on the family. When people remember that, they are less likely to make gift giving mistakes. Here are some guidelines for your estate plan giving.
Give early. Most estate planning gifts are made near the end of the year. That is holiday gift giving time, and it also is when people hurry to wrap up by Dec. 31 the things they meant to do all year. There are good reasons to make the gifts early in the year instead of later.
If you give property instead of cash, appreciation that occurs during the year reduces the amount of property you give tax free or increases taxes on the gift. For example, if you can give 100 shares of a mutual fund gift tax free in January and the fund increases 10% by December, you can give only 90 shares tax free at the end of the year. Estate and gift taxes are minimized when appreciating assets are given sooner rather than later.
If cash or income-producing property is given, a gift early in the year ensures that income for the year generated by that property is not on your tax return. Unless you need the income (in which case you probably should not be giving the property), give early in the year and let another family member who probably is in a lower tax bracket pay the income taxes.
Of course, a gift early in the year ensures that the gift actually is made and the property is out of your estate.
Give an extra amount. The tax law provides an annual gift tax exemption that is indexed for inflation. This year it is $12,000. A married couple can jointly give $24,000. The exempt amount can be given to any number of people each year, and there is no relationship requirement. Exempt gifts can be made to anyone.
There also is a lifetime gift tax exclusion of $1 million. Annual gifts above the exempt amount count against this exemption. To the extent the $1 million lifetime exemption is used, the estate tax exemption is reduced. When lifetime non-exempt gifts exceed $1 million, gift taxes are imposed.
Most people give the annual exempt amount and nothing more each year. If you can afford to live without the assets, however, consider giving more than the annual exempt amount.
If assets are appreciating, removing them from the estate now also removes the future appreciation from the estate. When an estate is unlikely to exceed the estate tax exempt amount, this is not important. But if an estate is likely to be taxable, the owner should consider removing appreciating assets early. Otherwise, at current tax rates only about half of each dollar of additional appreciation in the estate goes to the heirs, less if there are state taxes. For large estates, it makes sense to give amounts exceeding the $1 million lifetime exemption now. Pay taxes on the current amount and ensure there will be no gift or estate taxes on the appreciation.
Give appreciating gifts. One can give cash and personal property or appreciating property. To maximize tax savings, give the appreciating property. Giving appreciating property removes not only the current value of the asset from the estate but also the future appreciation.
Hold property with big gains. When property is inherited, the beneficiary increases the tax basis to its current fair market value in most cases. When property is received as a gift, the beneficiary usually takes the same tax basis the giver had. That means all the appreciation that occurred during the giver's ownership still is subject to capital gains when the beneficiary sells the property. But when someone inherits property, it can be sold immediately with no capital gains taxes being incurred.
Capital gains taxes are lower than gift and estate taxes. So, a balancing act might be required. If there is a choice of appreciating assets to give, it is better to give those with little or no embedded capital gains. But if the choice is between giving assets with embedded capital gains and giving cash or non-appreciating assets, it might be better to have the beneficiary incur capital gains when selling the property than to incur higher estate taxes down the road.
Keep loss property. There is no good reason to give business or investment property that has depreciated. The beneficiary's tax basis from such a gift would be the lower of the current value and the donor's basis, which means it would be the current value. No one would deduct the loss that occurred. It makes more sense to sell the losing property, deduct the loss on your tax return, and give the cash or other property to the beneficiary.
Don't forget unlimited tax-free gifts. There are two types of gifts that can be made in unlimited amounts and avoid gift taxes: education and medical gifts. We won’t review those special types of gifts in detail. The key point is that for education and medical gifts to be free of gift taxes in unlimited amounts the gifts must be payments made directly to the education or medical provider, not to the beneficiary.
Review the Kiddie Tax. When considering gifts to minors, keep in mind the latest version of the Kiddie Tax. The current version imposes the parent’s top tax rate on a child until age 18 (up from 16 a couple of years ago).
Maximize gifts in trust. Gifts don't have to be made directly to individuals. Gifts to a trust qualify for the annual exemption if the trust has a Crummey clause. To qualify for the exemption, a gift must be direct and immediate; the donor cannot retain the right to withdraw it or have it paid to him a later date. In addition, under the Crummey clause the beneficiary must have the right to withdraw the gift. The right to withdraw can expire after a period of time, such as 30 days. The beneficiary must be aware of the right to withdraw the gift. If the gift is not withdrawn in the time period, it stays in the trust and is subject to its limits. Of course, if a beneficiary does withdraw a gift from a trust, there is no obligation to make future gifts.
Add contingent beneficiaries. For gifts made to a trust, the annual exempt amount can be contributed to the trust for each beneficiary each year. If there are three beneficiaries, $36,000 can be contributed tax free if the trust has a Crummey clause. Contingent beneficiaries also increase the tax free gifts in most trusts. For example, your children can be the main beneficiaries of the trust and the grandchildren contingent beneficiaries. Meet with an estate planner to discuss how the trust must be written for contingent beneficiaries to increase the annual exempt amount.
There are numerous opportunities to remove assets from an estate at little or no gift-tax cost. The amount that is removed free of gift taxes can be increased by knowing the rules and shrewdly choosing which assets to give.