Estate Planning to Make Gifts While Avoiding Taxes
The estate tax is suspended for 2010, but the gift tax still is in place and will remain when the estate tax is restored. An advantage to adjusting your Estate Planning and making gifts in 2010 is the gift tax rate is its lowest in decades: 35%. Also the generation-skipping tax is repealed for the year, so you can make gifts in your estate planning directly to grandkids without worrying about that extra tax.
Because we still have the gift tax, when you want to help someone financially be sure not to trigger gift tax problems. When your estate is worth more than $3.5 million ($7 million for married couples) consider making gifts this year to get assets out of your estate ahead of next year’s estate tax, probable restoration of the generation skipping tax, and at the lowest gift taxes in decades.
Fortunately, there are a number of estate planning ways to help people without causing gift tax problems.
The annual gift tax exclusion remains. You can give anyone up to $13,000 of money or property each year without triggering gift taxes. You can make these gifts to as many people as you want (and can afford to) annually. Spouses who make gifts jointly have a joint annual exclusion per donee of $26,000. The annual exclusion is indexed for inflation, but only in $1,000 increments. So it can be fixed for several years before rising to the next level.
To qualify for the exclusion a gift must be immediate and direct. Putting money aside in an irrevocable trust or making a conditional gift doesn’t qualify for the exclusion. But money given to a custodial account for a minor (as long as you’re not the custodian) qualifies for the exclusion. Also, a trust with a Crummey power qualifies. A Crummey power allows the beneficiary to withdraw new gifts to the trust within a fixed time (usually 30 days) after receiving written notice the gift was made. When the time period expires, the gift becomes part of the trust and subject to its terms and restrictions.
In addition to the annual exclusion, each person has a lifetime gift tax credit that amounts to an exemption for $1 million of gifts. The credit is used only by gifts that exceed the annual exclusion. So you make your annual gifts up to $13,000, and then you can make additional gifts tax free until your $1 million lifetime exemption is used.
You can boost the amount of tax-free gifts with some savvy structuring of your gifts. Here are the top estate planning ways to increase tax-free gifts.
Education and medical expenses. In addition to your annual exclusion, you can make unlimited gifts each year for education and medical expenses. The payments must be made directly from you to the provider of the medical or education services. Any medical expense that would qualify as an itemized deduction on Schedule A of the income tax return qualifies for the unlimited gift.
Only tuition qualifies for the education exclusion. Other education expenses such as room, board, books, and supplies don’t. Education of any level qualifies for the exclusion, and multi-year prepaid tuition also is gift-tax free in the year of the gift.
College savings plans. The popular section 529 college savings plans receive special treatment. You transfer money to an account for a beneficiary. You still are the owner and can change the beneficiary. You also can withdraw the money without a tax penalty. The account earns income and capital gains tax free, and withdrawals by the beneficiary to pay for qualified education expenses are tax free.
Your transfers to the 529 plan qualify for the annual gift tax exclusion. In addition, you can bunch up to five years of gifts in one year and qualify for the exclusion. Currently you can put up to $65,000 in an account in one year tax free. But your exclusion for that person is used for the next five years. You can set up these plans for as many people as you want.
Family loans. We’ve discussed this issue before, because today’s low interest rates make loans unusually attractive these days. You lend money for less than a market interest rate. When you do, to avoid tax issues you need to charge a minimum interest rate set by the IRS each month. The rates are based on treasury debt rates, so they are very low. The latest rates require loans of more than nine years to charge a rate of only around 4%. Loans of three years and shorter need to charge only around 0.50%.
There are many estate planning ways to use loans to help people. Suppose a child ran up large credit card debts. You lend enough money to pay off the cards, charging 5% interest. The rate is far below what the credit cards charge, and probably more than you can earn on your investments. The child suddenly has more free cash flow.
Another strategy is to lend money to someone at a low interest rate. They can invest the money for several years for a higher return than the rate you charge. At the end of the loan term, you are repaid and the borrower keeps the excess investment returns. Those returns essentially are a tax-free gift from you.
Buy real estate. With home prices well below their peaks, this is a good time to help people buy homes. You can use the family loan rules to lend someone either the full purchase price or the down payment. Or you can buy the house. Then let an adult child or someone else you want to benefit live in the home. You can make the monthly rent a gift, letting them live there rent free. Or you can let them buy the house from you over time, essentially writing the mortgage yourself. Still another strategy is to make a gift to them each year of a portion of the home’s ownership, just enough to stay within the annual gift tax exclusion.
RW October 2010
