Many people make mistakes in their gift giving. It’s not their fault. The rules on estate planning gifts are tricky. By learning the tricks, you can increase the after-tax wealth available to you and your loved ones.
Reducing federal estate taxes no longer is the main motivation most of us have for making gifts, because a small percentage of estates pay the tax. Only those still subject to the tax (or its few state equivalents) still need to use gifts in their estate tax planning. For them and the rest of us, there are other
reasons to make significant gifts to loved ones and charities. Taxes still play an important part in how you should make those gifts, but income taxes matter more than estate taxes.
Whether or not your estate might be subject to federal estate taxes, a few shrewd moves can reduce the taxman’s share of your family’s wealth.
• Give early. When your estate could be subject to the federal estate tax, make gifts early and often. The
annual gift tax exclusion lets you give up to $14,000 annually free of gift taxes to each person you want. You can use the exclusion for gifts to any number of people, and no particular relationship is required. Gifts made under the exclusion don’t count against the lifetime estate and gift tax credit. Married
couples can make joint gifts of up to $28,000 per recipient tax free.
Also, consider making gifts that exceed the annual exclusion. Those gifts will be sheltered by your lifetime estate and gift tax credit and reduce the amount of the credit available to your estate. (The lifetime credit is $5.49 million per person, or $10.98 million for a married couple in 2017, and it rises
with inflation each year.)
I recommend giving early, because the gifts remove future appreciation from your estate. The more appreciating assets you retain, the more likely your estate will owe estate taxes or the taxes will increase. When it won’t diminish your financial security, transfer future appreciation to loved ones.
• Give early in the year. Most people wait until late in the year to make gifts. That’s partly because it’s the holiday season and partly because people generally wait until the last minute to do things. Gifts early in the year are better.
Giving early in the year ensures the gifts are made. They aren’t pushed aside by other activities or events. Also, the year’s income and gains are transferred to another family member’s tax return, preferably someone in a lower tax bracket. Early gifts enable you to more carefully select and plan the gifts. Late
year gifts often are made in a rush and can miss the optimum strategies.
If you haven’t made this year’s gifts yet, make them by the end of the year. Then, make next year’s gifts in January or February.
• Plan carefully for appreciated and appreciating property. Most people write checks when they make estate planning gifts. It is often better to survey the property you own and decide which assets are best to give.
When you give someone appreciated property, he or she takes the same tax basis in the property you had. When the property is sold, they’ll be taxed on the appreciation that occurred during your ownership. When appreciated property is inherited, however, the beneficiaries increase the tax basis
to current fair market value. All the appreciation during your ownership avoids capital gains taxes.
Suppose your loved one has a spending need. You plan to help by selling property that’s appreciated a lot. If they’re in a lower tax bracket than you, it would be better to give them the property. Let them sell and pay taxes at the lower rate.
Now, suppose your goal is to remove the asset from your estate, and the recipient is expected to hold the property for at least a few more years. When the recipient eventually sells the asset, they’ll pay capital gains taxes on the appreciation during both your holding period and theirs. It might make more sense to hold the highly appreciated asset in your estate so they eventually inherit it and increase the basis. That
way, the gains avoid taxes.
Instead, give an asset you expect to appreciate but that hasn’t appreciated much. You aren’t transferring a significant capital gains tax with the asset. Plus, the future appreciation is out of your estate.
• Don’t give investments with losses. When you give an asset that’s declined in value, the recipient’s basis is the lower of your basis and the current fair market value. No one deducts the loss. But if you sell the asset, you deduct the loss. Then, you can give the cash from the sale to the loved one, and you save some money on your taxes.
• Make unlimited tax-free gifts. There are a couple of types of gifts you can make tax-free in unlimited amounts. They also don’t count against your annual exclusion or lifetime estate
and gift tax credit.
Education gifts are tax-free in unlimited amounts when you pay for direct tuition costs. The unlimited exclusion doesn’t apply to payments for items such as books, supplies, board, lodging, or other fees. The gifts can be made on behalf of any individual, regardless of his or her relationship to you, and for any level of education. The gifts must be made directly to an educational institution.
Medical gifts also are gift-tax free without limit when payments made directly to a medical care provider for items that would qualify as deductible itemized medical expenses on Schedule A of the income tax return.
• Make real gifts. To qualify for the annual gift tax exclusion and to be out of your estate, the gift must be of a “present interest.” Basically, that’s a gift without strings attached or the right to recall it. So, of course, you shouldn’t give money or assets you might need during retirement.
Many people understandably are hesitant to give valuable property to younger generations. They want the youngsters to retain the assets and benefit from the appreciation or income stream for years. They’re afraid the youngsters might sell the assets and spend the proceeds right away.
One way to achieve your goals is to make gifts through a trust with a Crummey clause, named after a famous court case. Generally, gifts made to a trust don’t qualify for the annual exclusion, because the beneficiaries don’t have direct access to them. But the trust can have a clause that allows beneficiaries to elect to have the gifts distributed to them. Gifts to the trust then are a present interest, according to
the Crummey case.
The Crummey clause can set a time limit for withdrawing the money. If the beneficiaries don’t act by then, say within 30 days after the gift to the trust, they lose the right to elect a distribution. You should notify the beneficiaries in writing when a gift is made and that they have the limited withdrawal right. Of course, you can make clear to the beneficiaries there won’t be any more gifts if they elect a distribution.