Maximizing Tax-Free Gifts for Estate Planning

Stock prices are down. Real estate still is on the floor in many areas. Family members probably could use some financial help. The estate and gift tax exemptions are higher. Add those facts, and you find this is a great time to do spme Estate Planning and give away assets to loved ones, avoiding estate and gift taxes now and in the future.

Estate and gift taxes are imposed on the value of property. If a mutual fund has declined in value, you can give more shares tax free than you could before the decline. At some point, the price likely will recover. Your loved one will have the additional wealth, and you gave it estate and gift tax free. That’s why market declines are the prime time to consider accelerating a gifting strategy. This estate planning strategy applies to stocks, mutual funds, bonds, real estate, small business interests, and other assets.

You can use the tax law to maximize the amount of future appreciation that can be given tax free today.

The annual gift tax exclusion lets you give away $13,000 per recipient free of gift taxes in 2011. A married couple jointly can give $26,000 tax free to each person. You can make these gifts to as many people as you want each year. To qualify for the annual exclusion, the gift must be of a present and immediate interest. That means contingent gifts or future gifts don’t qualify, but there’s a way around that.

Maximize trust gifts. Gifts to a trust qualify for the annual exemption if the trust has a Crummey clause. This gives the beneficiary the right to withdraw the gift for a period of time after the gift is made to the trust. The right to withdraw can expire after a period of time, such as 30 days, and the beneficiary must be made aware of the gift and the right to withdraw it. If the gift is not withdrawn in the time period, it stays in the trust and is subject to its terms. Of course, if a beneficiary does withdraw a gift from a trust, there is no obligation to make future gifts. You can maximize tax-free gifts and protect the wealth by giving to trusts with Crummey clauses.

Add contingent beneficiaries. The annual gift tax exemption can be contributed for each beneficiary of a trust. If there are three beneficiaries, $36,000 can be contributed tax free when the trust has a Crummey clause. Contingent beneficiaries also increase the tax free gifts in most trusts. For example, your children can be the main beneficiaries of the trust and the grandchildren contingent beneficiaries. Your estate planning advisor should know how the trust must be written for contingent beneficiaries to increase the annual exempt amount.

Gifts exceeding the annual exclusion still are tax free, because of the lifetime estate and gift tax exclusion. This exclusion currently allows you to give up to $5 million during your lifetime. To the extent you use it to shield gifts, it reduces the estate tax exemption by that amount. Because assets tend to appreciate over time, it makes sense to give property and use the exemption now rather than later, if you can afford to. You shift more future wealth out of your estate by giving now. Also, it’s possible that the $5 million lifetime exemption will be decreased in the next few years. If you think that’s likely, you might want to take advantage of the $5 million exemption while it’s available.

You also increase tax-free gifts by helping loved ones with medical and education expenses. These gifts are tax-free in unlimited amounts when you pay the provider of services directly. The medical expenses must meet the definition of deductible medical expenses. Qualified education expenses are tuition, books, fees, and related expenses but not room and board. You can find the detailed qualification in IRS Publications 950 and Form 709.

You can leverage these rules to really maximize your gifts by using these estate planning strategies.

Give early. Most people wait until the end of the year to make estate planning gifts, but you want as much appreciation out of your estate as possible. That means you should give either at the start of the year or when prices are at a low point during the year instead of waiting for December. Giving income-producing property during the year also removes the year’s income from your tax return, putting them on the returns of the gift recipients.

Give property that will appreciate. Cash is nice, but to maximize tax-free giving you want to dispense assets that you expect to appreciate over the years and remove the future appreciation from your estate. And you probably want your loved ones to have something for the future instead of cash to spend today.

Retain property with big gains. The donee of your property takes the same tax basis you had in appreciated property. He’ll pay the capital gains taxes eventually when the property is sold. But when property is inherited, the tax basis is increased to its current fair market value in most cases. The appreciation that occurred during your ownership escapes capital gains taxes under current law. When you can, keep property that appreciated a lot while you’ve owned it. Give property you expect to appreciate but that doesn’t yet have substantial capital gains.

Keep loss property. When property depreciated during your ownership, the beneficiary’s tax basis is the lower of the current value and the your basis, which means it is the current value. No one gets to deduct the loss that occurred during your ownership. It’s better for you to sell the property, deduct the loss on your tax return, and give the cash proceeds. Or find other property to give.

Review the Kiddie Tax. When gifts are made to minors, keep the latest version of the Kiddie Tax in mind. When the investment income of dependent children exceeds certain levels, taxes are paid at the parents’ top tax rate. You can find details in IRS Publication 17.

You can maximize tax-free gifts even when you want to protect wealth from mistakes, waste, and outside forces. Consider these estate planning strategies and tools.

529 plans. College savings plans authorized under section 529 of the tax code are one of the best estate planning vehicles Most states now offer multiple 529 plan options, and any person can set up an account for the benefit of someone else and contribute to it. Plan contributions qualify for the annual gift tax exclusion, currently up to $13,000 per year. In addition, up to five years’ worth of exclusions can be used in one year for a tax free lump sum contribution of up to $65,000. The money given to the account is out of the donor’s estate unless he dies within five years. Under many state plans the owner has some choice over how the account is invested.

Income and gains in the account compound tax free. Withdrawals are tax free when they are used for qualified education expenses of the beneficiary. (See the discussion in this issue.)

A distinct advantage of the 529 plan is the owner can retrieve assets from the account for any reason. There is no tax penalty if the owner asks for the return of the assets, though the plan sponsor can impose a penalty of up to 10%. The owner also can change the plan beneficiary at any time.

Some states limit the duration of an account to a number of years or to the 25th or 30th birthday of the initial beneficiary. Others have no time limit.

Bill paying assistance. You can give by making direct payments on behalf of the beneficiary. The beneficiary never touches the money, and the gifts pay for what you intend. Some people pay directly for vacations, summer camps, furniture, clothing, cars, and other expenses.

Direct payments qualify for the annual gift tax exclusion. As mentioned earlier, qualified education and medical expense payments made directly to the provider qualify for an unlimited gift tax exclusion.

Home equity match. Suppose loved ones need an expensive item, but the parents are not able or willing to part with a large lump sum or want to stay within the annual gift tax exclusion limit. An estate planning strategy, if the children have adequate home equity and credit, is for the children to make the purchase with a home equity loan. The parents then can agree to make all or part of the loan payments either directly or by sending money to the children. This allows the parents to help the children, stay within the gift tax exemption amount, and spread the payments over time in manageable amounts. The children deduct the interest.

Expense matching. Some donors to charities make challenge matches. They offer to match, up to a maximum amount, whatever amount the charity raises from other donors for a specific purpose. Parents can do the same with children. If the children need or want a car, for example, the parents can offer to match whatever amount the children spend. The match does not have to be dollar for dollar. The parents can offer to pay fifty cents for every dollar the children pay or some other ratio.

RW September 2011.