Financial Advice for Retirement, Social Security, IRAs and Estate Planning

How to Maximize Power Of Gifts in Your Estate Planning

Last update on: Jun 23 2020
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Gift-giving season is on the way. Many people use this time of year to make not only the traditional holiday gifts, but also to make gifts as part of their Estate Planning. Annual gifts are a powerful part of any estate planning. If you are going to make gifts, you might as well get the biggest tax and financial benefit from them that you can. And you should avoid some mistakes a number of gift givers make.

In your gift and estate planning, remember that gift and estate taxes are based on the value of property at the time the tax is imposed. That principle and a few sections of the tax law will guide you to some shrewd gift giving practices.

Give early in the year. Most people make their estate planning gifts around the holidays, partly because it is the end of the year and partly because it is the gift giving season. But early gifts make a lot more sense.

A gift early in the year takes any income that property produces during the year off your income tax return. That’s a smart move unless you need that income. It is especially smart if the gift is to someone in a lower tax bracket, so the family will pay lower taxes on that income.

In addition, giving early in the year might allow you to make a larger gift. Since the tax is based on the gift’s value, if the property appreciates during the year you can give less tax free. Remember that you can give away to everyone you want up to $10,000 annually free of gift taxes ($20,000 if you and your spouse give jointly). If you have some mutual funds worth $10,000 in January and they appreciate by 10% during the year, you can give away only $10,000 worth tax free in December and have the other $1,000 in your estate. If you had made the gift in January, the entire $11,000 is out of your estate tax free.

Giving early in the year also ensures that your $10,000 tax free gift allowance for the year is used. Something could happen to you during the year that keeps you from making the gift and keeps the property in your estate. That could cost your estate a few thousand dollars, depending on your tax rate.

Maximize your tax free gifts. In addition to the annual $10,000 gift tax exclusion (which is indexed for inflation after this year), there are a couple of opportunities to make unlimited tax free gifts.

Education gifts are allowed tax free in unlimited amounts if 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 education institution and can be made on behalf of any individual regardless of his or her relationship to you.

Medical gifts are payments made directly to a medical care provider and qualify for unlimited tax free gifts. The gifts must be made for expenses that would qualify as deductible itemized medical expenses.

Give more than the tax free amount. Many people limit their generosity to the annual tax free allowance. That can cost your estate a lot of money. Remember that estate and gift taxes are based on the value of property at the time the tax is imposed. That means if property is appreciating, it will incur much higher estate taxes down the road than the gift taxes that would be due today. If you don’t need the property to maintain your lifestyle, seriously consider giving more than the annual tax free amount to get appreciating property out of your estate.

Another reason to give more is the annual lifetime credit. This can be used against either estate or gift taxes. Many people save it for estate taxes. But because of inflation and the appreciation of property, your heirs probably would be much better off if you use up the lifetime credit early and get the property out of your estate now.

Another reason to give away property now is, because of the complicated way estate and gift taxes are computed, you and your estate pay less overall taxes if you pay gift taxes on property instead of estate taxes. I won’t work through the calculations, but estate planning specialist agree that is the case. The bottom line is that if you don’t need property to maintain your standard of living, consider giving it away early instead of in your will.

Factor in potential capital gains and losses. You should look at more than the value of property that you give away. You have to look at the capital gain or loss in the property, who might pay it, and when it might be paid. When property is given away, the recipient takes the same tax basis that you had. That means any gain or loss is deferred until the recipient sells the property. Here are some ideas to keep in mind.

  • It generally is a bad idea to sell property in which you have a paper loss. Instead, sell the property, deduct the loss on your own tax return, and give away the cash proceeds. Exceptions to this rule are when you already have more capital losses than you can use and when the recipient is in a higher tax bracket than you are.
  • Suppose the property will be sold at a gain right after the gift, so that the recipient can spend the cash. If the recipient is in the same tax bracket as you, consider selling the property, paying the capital gains taxes yourself, and giving away the after-tax proceeds. Otherwise, you’ll be paying gift taxes or using your gift tax exclusion on the part of the property’s value that is earmarked for capital gains taxes.

But if the recipient is in a lower tax bracket than you, give away the property. That way, capital gains taxes will be paid in a lower bracket, and the family will have lower taxes and more after-tax cash.

Give appreciating property for long-term holding. Sometimes gifts are made with the expectation that the recipient will use the wealth to pay current expenses. But often gifts are made to help build long-term financial security. The best way to accomplish this purpose is to give away property that you anticipate appreciating over the years. When you do that, not only is the property’s current value out of your estate, but so is the future appreciation. In addition, you’ll be shifting the capital gains taxes off your tax return and onto someone else’s.

One caveat to this strategy is that the recipient ultimately will owe capital gains taxes when the property is sold. So you might not be giving the recipient as much after-tax wealth as you might think. The best way to avoid this problem is to select property that has not appreciated much but is likely to in the future, if you own such property.

Planned gift-giving is one of the best ways to slash your estate and gift taxes, leaving your heirs better off. But the IRS knows this is the case and is stepping up its review in these areas. The biggest issue to the IRS is the valuation of gifts of property. Because of this you should get help from an attorney or accountant when considering non-cash gifts in your estate planning.

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