The start of the year is the best time forestate plan-motivated gifts. Even if you made gifts late in 2018, consider making your 2019 gifts soon.
Estate tax reduction used to be the major incentive for annual giving to family members. Now, only the very wealthy need to make gifts to reduce estate and gift taxes. Gifts still should be part of your estate plan.
There are sound reasons other than estate and gift taxes for those outside the top 1% in wealth to make annual lifetime gifts. One advantage is that you see how your loved ones use the gifts. That can give you satisfaction. It also helps you see how they handle wealth. The experience might change how you give in the future and the amount you give. Lifetime giving also provides loved one’s opportunities to learn how to handle wealth.
With lifetime gifts, you improve the lives of your loved ones now, and the extra resources might mean a lotto them. They could be struggling to buy a home, pay for their children’s education, or reach other financial goals. Giving now might help them more than knowing they’ll probably receive a more significant, but uncertain, sum at some unknown date in the future.
Shrewd gift giving also can reduce family income taxes, increasing the family’s after-tax wealth, which we’ll discuss shortly. You probably can think of additional reasons why it might be better to make your estate planning gifts sooner rather than later. Most people wait until near the end of the year to make gifts. That’s partly because it is the traditional gift-giving season and partly because people procrastinate.
Yet, there are tax, financial and personal reasons to give early in the year. Scheduling your gifts early in the year ensures that your giving plan is executed. If you wait, events could intervene that prevent the gifts from being made this year. When you plan to give investment property that produces income, giving early in the year removes the income from your tax return.
Early giving ensures that other family members pay the income taxes and they might be in lower tax brackets than you. That increases the family’s after-tax wealth. You can better exploit the annual gift tax exclusion by making gifts early in the year.
Under the exclusion, you can make gifts up to a certain amount to a person each year without it count-in against your lifetime estate and gift tax exclusion. The 2018 limit was $15,000, and the limit for 2019 remains $15,000. You can make gifts up to $15,000 each to as many people as you want each year. If you have three children, you can give each up to $15,000 of money or property each year. Your spouse also can give $15,000 to each child, or the two of you can give jointly up to $30,000 to each child.
The property’s value on the date of the gift is used to determine if you reached the exclusion limit. When you give property that’s likely to appreciate, it’s usually better to give early in the year. Suppose you plan to give mutual fund shares that have net asset value of $10 at the start of the year.
If you wait until the end of the year to give and they are worth $11 at that time, you can give more than 136 fewer shares under the exclusion. Giving early in the year, when values are rising, would enable you to give more shares tax free, because you gave the shares before they appreciated.
For similar reasons, you might want to give more than the annual gift tax exclusion amount. Gifts that exceed the annual exclusion reduce your lifetime estate and gift tax exemption. Each person has a lifetime exemption. It’s indexed for inflation and, in 2019, the exclusion is $11.4 million. That means a married couple effectively has a joint $22.8 million lifetime exemption. (See the next article in this issue.)
If you can afford to give more than the annual exclusion, consider doing so. The property and its future appreciation are removed from your estate at today’s value. All the future appreciation won’t absorb any of your lifetime exclusion. If you continue to own the property and it appreciates, you take the risk your estate will exceed the lifetime exemption.
That’s especially true if the estate tax exemption is reduced in the future. Once you’ve decided to harvest the benefits of giving early in the year and giving more than the annual exclusion, consider some other strategies that will increase the after-tax value of your gifts. You can maximize tax-free giving each year by making gifts for education and medical care.
Under certain conditions, these gifts are tax free in unlimited amounts each year. Unlimited education gifts are tax-free when they pay for direct tuition costs and not for items such as books, supplies, board, lodging, or other fees.
To qualify, the gifts must be made directly to an educational institution. The gifts can be made on behalf of any individual, regardless of his or her relationship to you, and for any level of education. Medical gifts are allowed in un-limited amounts when payments are made directly to a medical care provider and are for items that would qualify as deductible itemized medical expenses on Schedule A of the income tax return.
When these conditions are met, unlimited tax-free gifts are allowed. Remember that these two types of tax-free gifts are in addition to the annual gift tax exclusion amount and don’t count toward your lifetime exemption.
While most people give cash, it’s often better to give investment property. Some studies have shown that family members who are given investments often save more of their own money and accumulate more personal wealth than those who received cash gifts.
A good long-term strategy is to make gifts of property that are likely to appreciate over time. Transfer the property at today’s value to your children or grandchildren and let them reap the benefits of the appreciation. The appreciation will avoid estate and gift taxes. But you might not want to give property that’s already appreciated a lot if you could give other items.
When property is inherited through your estate, the heirs increase the tax basis to its current fair market value. They can sell the property immediately and owe no capital gains taxes. The appreciation that occurred during your lifetime isn’t subject to capital gains taxes. When you make a lifetime gift of property that’s already appreciated, however, the beneficiary takes the same tax basis you had.
When the property eventually is sold, he or she will owe capital gains taxes on the appreciation that occurred while you held the property. That might not be a bad thing if the recipient is in a lower tax bracket than you and you were planning to sell the property anyway. But if property with a lot of appreciation is going to be held long term, it’s better that you hold the property and let it be inherited through your estate. That avoids capital gains taxes on all the appreciation.
That’s a good result, especially since for most people estate taxes are likely to be zero; there’s no tax penalty for holding the property in your estate. Don’t give investment property in which you have a paper loss. The tax basis for the recipient is the lower of your basis and the current fair market value. That means the recipient will have a tax basis of its current fair market value.
When the property is sold, no one will receive a deduction for the loss that was incurred while you held it. It is better for you to sell the property, take the loss deduction and give away the sale proceeds. Planned gift giving is an important part of financial and estate planning.
Of course, don’t give away wealth that you might need during your lifetime. Once your lifetime needs are secure, however, planned giving can increase your family’s after-tax wealth and you’ll be able to see how your gifts improve loved ones’ lives.