The Investment Scientist

To Reduce Estate Taxes: Gift It Away

Posted on: September 22, 2011

Estate Tax[Guest post by Christopher Guest] One of the areas of estate planning that causes the most confusion is gifting. Gifts are transferred from a donor to a done in several ways. Gifting has a huge diversity of answers in how gifting is accomplished.

Here are some basics on gifting. The IRS considers any gift from one person to another a taxable gift. But, there are some exceptions to the rule:

  1. Gifts of any property that are not more than the annual exclusion for the calendar year. (Note – the annual exclusion is $13,000 for 2011.)
  2. Tuition or medical expenses you pay for someone (the educational and medical exclusions).
  3. Gifts to your spouse.
  4. Gifts to a political organization for its use.

Further, gifts to qualifying charities are deductible based on the value of the gifts made. Gifts of a future interest cannot be excluded under the annual exclusion. A future interest would be when the donor makes a gift to the done, but the donee will only gain access to the gift years down the road.

Property gifted may be straight cash, a car, stocks, etc. For non-cash gifts or assets without a ready known value, the gift’s value is considered the fair market value. Fair market value is defined at what would the property change hands between a willing buyer and willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

A typical situation of an excluded annual gift is when a parent gifts $13,000 to a child. Married couples can also gift-split meaning each parent can gift to a child $13,000 for a total of $26,000 – $13,000 from each parent. If a child is married, the married couple can each gift the spouses $13,000 for a total gift of $52,000.

If a gift is valued at more than the annual exclusion then it is considered a taxable gift with a safe harbor has shown below. A gift tax is owed. The gift tax is generally the responsibility of the donor. Yes, that’s right. The person giving the gift away to another person is socked with paying tax on that gift. The main reason the donor pays the tax is that once the gift is transferred, that asset is no longer in the donor’s estate for estate tax purposes. The IRS’s assumption, and it is a winning one, is that the gift was done in contemplation of minimizing a person’s taxable estate for tax purposes.

In addition to the removal of the gift from a person’s estate, there are some added benefits to making a gift in excess of the annual exclusion. In 2011 and 2012, everyone has a five (5) million dollar lifetime exclusion. This means that an annual gift in excess of $13,000 in 2011 will consume a part of that person’s lifetime exclusion. For example, Dad gifts $500,000 to Son in January of 2011 to buy a house. The first $13,000 of Dad’s gift is not subject to the gift tax because of the exclusion. The remaining $487,000 is a taxable gift. That $487,000 is subtracted from Dad’s Lifetime amount leaving $4,513,000 remaining in Dad’s Lifetime Exclusion that Dad can still gift away in 2011 and 2012 and, depending on whether the rules change in 2012 or later, possibly beyond 2012.

The Lifetime Exclusion was not always so generous, but that was changed in the Tax Compromise of 2010. From 2001 until the Tax Compromise, there was only a $1 million Lifetime Exclusion. The increase of the Lifetime Exclusion from to $5 million has seen a number of affluent Americans transferring assets to their beneficiaries or creating high level estate planning entities like grantor annuity trusts to reduce their taxable estate.

In the past, another reason people made taxable gifts was that the gift tax rate was lower than the estate tax rate. Currently, the estate tax rate and the gift tax rates are the same.

If there is anything that you can take away from this is that you can gift $13,000 to anyone else. If you exceed the annual exclusion you would consume part of your Lifetime exclusion.

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2 Responses to "To Reduce Estate Taxes: Gift It Away"

Wow – finally an explanation that I can understand on these gift and estate issues. I’ve heard parts of all this, but never felt I had a good understanding of the whole thing.

Thanks!

David Kaminski, MD, FACEP

David,

Glad you find it useful. My goal for the blog is to have short and to-the-point articles that help my readers understand key wealth mgmt issues.

By the way, come join me on Google+ and FB, I have more frequent updates there. I will put you in my physician circle:

https://plus.google.com/107502953367248667573/posts

http://www.facebook.com/pages/Physicians-Wealth-Management/248571977641

Michael

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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