Gift Giving: A Way To Save Estate, Gift and Income Taxes


Gift Giving, Use of Annual Donee Exclusion, Unified Credit, Clawback provisions

Tax Advantages of Gift Giving

Written By Philadelphia Tax, Estate and Probate Attorney, Steven J. Fromm on 1/04/2021

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:

The Annual Donee Exclusion

Taxpayers sometimes fail to recognize they can give $15,000 (2021 amount that rises over time based on cost of living index adjustment) 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 (recipient of the gift) 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 $75,000 to beneficiaries without any estate or gift tax costs. If this was done over a 10 year period, $750,000 would be exempt from estate and gift taxes. With marginal federal estate tax brackets starting at 40% (on amounts above the current unified credit amount), the savings would be $300,000.

In addition, lifetime gifts can save state inheritance taxes, depending on the state in question. For example, in Pennsylvania if the donor lives for a year after the gift, the gift is outside of his taxable estate and there is no inheritance tax due on such gift.

Spousal Joinder For The Annual Donee Exclusion

In addition, the spouse can join in a present interest gift for an additional $15,000 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 $75,000 to be gifted by the father estate and gift tax free. As a result, with his spouse joining in the gift, he could give away $150,000 each year and over ten years he could give away $1,500,000. As a result the family could save $600,000 in estates taxes.

Using The Unified Credit During Lifetime

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 $11,700,000 in 2021 (subject to annual 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 available unified credit amount at death. So if he donor uses up $10,000,000 on lifetime gifts (above the annual donee exclusion and spousal joinder), he or she would have a remaining $1,700,000 exemption available at his death.

Special Note About The Unified Credit: Although the federal unified credit is quite large right now, with large federal deficits in our future, it is likely this unified credit amount will be greatly reduced.   Before the tax act that increased the unified credit to these large amounts, the unified credit was increased over time to $5,000,000.  A new tax act may reduce the unified credit to this amount or even to a lower amount like $3,000,000 or $3,500,000.

Claw-back Provision Will Not Be Imposed By IRS For Using Large Unified Credit Before a Tax Law Change That Reduces Unified Credit:

For taxpayers will large estates, it may be to their advantage to use the very large current unified credit while it lasts to save estate taxes for their family.  The IRS has stated if this amount is used up and the tax law later changes, the IRS will not force the taxpayer to give back the credit used up.  In other words, the IRS will not disallow the prior use of the large exemption.  As a result the IRS will not use what is called a “clawback” provision to penalize taxpayers who used the available large unified credit before a change in tax law.

Gifts That Are Exempt From Gift Taxes

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.

Gifting Through An Irrevocable Life Insurance Trust (ILIT)

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.

Taking Advantage of Discounts For Minority Interests and Lack of Marketability

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 (especially if the amount of ownership at death represents a minority interest) may be subject to discounts in the donor’s estate upon his death.

Income and Other Estate Tax Advantages

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 (children of the maker of the gift) death if such assets were first transferred to such parents and then they are transferred at their death to their children.

Gift Tax Return Required When Gift Exceeds Annual Exclusion

Gift tax returns do not need to be filed unless you give someone, other than your spouse, money or property worth more than the $15,000 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.

Warning

These gift giving techniques are some but not all of the gift giving strategies that are available to taxpayers.  These gifting strategies 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. Therefore, 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 tax strategies tailored to your current situation and family wealth transfer goals.

For a situation where it may not make sense to make a lifetime gift please read The Biggest (Tax) Loser: Misguided Gifts of Real Estate By Uninformed Do It Yourselfers, Realtors & Attorneys

For more information concerning gift giving please read IRS Checking Real Estate Transfers For Unreported Gifts.

Steven has been providing outstanding legal advice to me for seventeen years. He is THE authority on estate planning and financial planning. Steven is a compassionate and thorough attorney who thinks of every possible contingency. He easily explains complicated issues, and it has been my pleasure to recommend him to my friends.”

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