Gift giving can generate both estate and gift tax savings in the appropriate situation. In addition, by transferring assets to family members income taxes can be saved. The following illustrates some of the basic gift giving strategies available to taxpayers. However, these strategies should be employed only if it makes sense from a financial perspective. Here are some of the basic tools to maximize the tax benefits of gift giving:
Taxpayers sometimes fail to recognize they can give $14,000 per year to as many donees as they desire. Note that this gift must be a present interest gift as defined by the Internal Revenue Code, regulations and case law. Basically, a present interest gift is one where the recipient of the gift can enjoy the immediate benefits of such a gift in a significant way. This is a defined tax law term but basically the donee must have the present enjoyment and possession of the gift for it to qualify for the annual donee exclusion. Outright gifts with no strings attached qualify as present interest gifts. Gifts in trust usually do not qualify for the present interest gift tax exclusion. However, if the trust is drafted with something called a Crummey provision a present interest gift may be present.
The benefit of using the annual donee exclusion can be seen through the following example:
Example 1: Suppose a father wants to make a gift of the annual donee exclusion amount to say 5 children during the year. This will allow him to transfer $70,000 to beneficiaries without any estate or gift tax costs. If this was done over a 10 year period, $700,000 would be exempt from estate and gift taxes. With marginal federal estate tax brackets as high as 45%, the savings would be $315,000.
In addition, these gifted amounts may not be taxable for state inheritance tax purposes depending on the state in question. For example, in Pennsylvania where the donor lives for a year after the gift, the gift is outside of his estate and there is no inheritance tax due on such gift.
In addition, the spouse can join in a present interest gift for an additional $13,000 annual donee exclusion. This would double the amount of gifts that can be given via the annual donee exclusion.
If we look back at Example 1, this would allow for another $70,000 to be gifted by the father estate and gift tax free. As a result, with his spouse joining he could give away $140,000 each year and over ten years he could give away $1,400,000. As a result the family could save $630,000 in estates taxes.
Where a taxpayer has an asset that is expected to appreciate greatly in the future, it sometimes make sense to gift the property at its current value. This may use up some or even all of the unified credit but it may make tax sense to do so. Currently, the unified credit is $5 million dollars (plus adjustments for inflation) and can shelter any large lifetime gifts. The amount of this unified credit that is used during lifetime will reduce the then availabel unified credit amount. So if he donor uses up $3 million on lifetime gifts (above the annual donee exclusion and spousal joinder), he or she would have a remaining $2 exemption available at his death.
Certain gifts can be made above and beyond the annual donee exclusion without limit. Gifts made as a result of direct payment of medical expenses and tuition expenses paid on behalf of another are not taxable gifts as long as the payments are made directly to the medical provider or school.
Owning a life insurance inside an irrevocable life insurance trust may allow for dual tax benefits. First, if structured correctly the insurance proceeds would be free of federal estate taxes. Secondly, payments to the trustee that are used to pay premiums on such policy can utilize the annual donee exclusion if certain procedures and requirements are met. The use of so-called “Crummey notices” are essential. Finally, care must be taken to deal with the so-called three year rule if a current policy is transferred to an ILIT.
Gifting of shares in a family limited partnership, in a closely held business or partnership can reduce the value of gifts by the use of certain discounts. Where the donor is giving the donee a minority interest that in most cases will not be freely transferable, the IRS permits the valuation of such gifts to be discounted for such limitations. In addition, as gifts are made the ownership interests of the gifting owner are reduced and these remaining interest may be subject to discounts in the donor’s estate upon his death.
By transferring assets downstream to younger generations, the income that is generated by such gifted assets will be taxed in the lower tax brackets of such younger generations. However, be aware of the so called “kiddie tax” rules that forces children’s income to be taxed at their higher parent’s tax brackets.
Also, if grandchildren are directly gifted assets estate tax savings may result. Such gifts bypass the estate taxes that may have been due at their parent’s death if such assets were first transferred to such parents and then they are transferred at their death to their children.
Gift tax returns do not need to be filed unless you give someone, other than your spouse, money or property worth more than the $14,000 annual donee exclusion for that year. Also gifts that are not of a present interest would trigger a gift tax return. Also, a spousal joinder election requires the filing of the gift tax return, Form 709.
These gift giving techniques can save families a large amount of taxes if implemented correctly. This requires the proper documentation, implementation and filing of the required tax returns and elections where applicable. It is imperative to seek the services of trained and experienced tax/estate counsel to assist you. Do not hesitate to contact us to explore the possibilities in your current situation.
For more information concerning gift giving please read IRS Checking Real Estate Transfers For Unreported Gifts.
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