Shrewd Family Gift Giving for Estate Planning

Don’t wait until the end of the year to plan gifts to family members. Annual gifts are an important part of Estate Planning, but most people don’t handle gifts the best way. Estate planning gifts now will increase the amount of wealth that is transferred tax-free to your heirs.

The goals of gift-giving are to get property out of your estate and to minimize estate and gift taxes. Careful timing of the gifts and selection of the property to give can greatly increase the benefits of regular estate planning gift giving.

Give early in the year. Most people wait until December to make the annual gifts. But giving early in the year has some benefits. It gets any income the property generates during the year off your tax return. When the donee is in a lower tax bracket, the entire family has more after-tax wealth. In addition, early gifts ensure that nothing happens to prevent the gifts from being made by the end of the year.

Early gifts also can increase the amount of wealth you can give away. You can give only $11,000 tax free each year. Suppose assets are appreciating. If a mutual fund has a net asset value of $50, you could give 220 shares now. If the market recovers and the shares appreciate 20%, at the end of the year you could give only about 183 shares. The sooner you give property that is likely to appreciate, the more property can be removed from your estate tax free.

If you are planning gifts for later this year, also plan gifts for January of 2005.

Give more than $11,000. You can give $11,000 free of gift taxes to each donee annually. A married couple can jointly give $22,000 tax free. But the rationale for giving early in the year also is a rationale for making gifts above the tax-free amount.

The rationale is simple. Estate taxes are imposed on the value of the estate. Remove appreciating property from an estate early, and more of the future appreciation avoids estate and gift taxes. To the extent that you can afford it, give property now to your heirs.

When a gift exceeds the $11,000 annual gift tax exclusion, it first reduces the lifetime estate and gift tax credit, currently at $1.5 million per person. Once the lifetime credit is exhausted, gifts become taxable. But if the asset is appreciating, it is cheaper for the family if gift taxes are paid now instead of estate taxes later.

Learn how to give more than $11,000 per person tax free each year. There are two ways to make unlimited tax free gifts.

Education gifts are tax free for an unlimited amount if they pay for direct tuition costs. Gifts that pay for other education expenses do not qualify for this exception, including books, supplies, board, lodging, or other fees. The payments must be made directly to the education institution to qualify for the unlimited tax free treatment.

Medical expenses also can qualify as tax free gifts without limit. Qualifying payments are those made for any medical expense that meets the definition of a deductible itemized medical expense. Again, the payments must be made directly to the medical care provider.

Use a Crummey trust to give property tax-free. Trusts are used when you don’t want to give wealth directly to the beneficiary. For example, the beneficiary might be young or might not be responsible with money.

Normally gifts qualify for the annual exclusion only when they are immediate gifts of present ownership. A trust must have Crummey powers for gifts to it to be considered a direct and immediate gift.

The Crummey power is a trust clause that allows the beneficiary, within a stated time period, to withdraw any new gifts to the trust. Thirty days appears to be the most common time period for the withdrawal. If the gift is not withdrawn within that period, it stays in the trust subject to all the terms and limits of the trust. The beneficiary cannot withdraw it at a future time, unless other trust provisions give that right. The beneficiary knows that if the withdrawal power is exercised once, you are unlikely to make future gifts to the trust.

The IRS does not like the Crummey trust. Be sure you get advice from an experienced estate planning advisor before setting one up.

Increase trust gifts with contingent trust beneficiaries. With a Crummey trust, you can make annual tax free gifts to the trust of up to $11,000 for each beneficiary. If the trust has three beneficiaries, you can give $33,000 tax free to the trust each year.

The tax free gifts can be increased by naming contingent beneficiaries of the trust. For example, name your children the primary beneficiaries, and your grandchildren as the contingent beneficiaries. Say you have three children and three grandchildren. Then, one spouse can contribute $66,000 annually to the trust free of gift taxes. The trust can be written so that the children get the benefits of the trust and the grandchildren benefit only after their parents pass away.

Give property that is likely to appreciate. We already have seen how this estate planning strategy works. The idea is to get future appreciation out of the estate unless you need that property to maintain your standard of living. The more future appreciation that is out of the estate, the lower the total estate and gift taxes are on the family’s total wealth. If you have a choice of properties to give, give those that are likely to appreciate the most.

Hold assets with substantial appreciation for your estate. If you give property that already has appreciated to someone, the donee takes the same tax basis that you had. That means the appreciation during your lifetime eventually will face capital gains taxes.

If you hold the property for life, however, the basis of the property is increased to its fair market value when it is inherited. Then, your heirs can sell it and not owe any capital gains on the appreciation that occurred during your lifetime. Of course, since the property is in your estate it might be hit with estate taxes if you don’t plan to reduce them.

These last two estate planning strategies require a balancing act. You want to give away property that is likely to appreciate in the future. But if the property already has appreciated a lot, it might be better to hold the property and let the basis get increased in your estate.

Don’t give losing property. When property has declined in value and you make a gift of it, the recipient’s tax basis is the lower of your basis and the current fair market value. That means if you give property with a paper loss, no one gets to deduct the loss. It is better for you to sell the property, deduct the loss on your tax return, and give away the cash from the sale. If you want the property held long-term, do not give it until the current fair market value at least equals your basis in it.

Remember the kiddie tax. An objective of gift giving sometimes is to move income-producing property from your higher tax bracket to a family member in a lower tax bracket. If investment income is earned by a child under age 14, the first $800 is tax free; the next $800 is taxed at the 10% or 15% rate. Any investment income above $1,600 (indexed for inflation) is taxed at the parents’ highest tax rate. Once the child turns 14, the Kiddie Tax doesn’t apply. That means if you are giving property that generates a lot of income or capital gains, be careful not to give too much income until a child or grandchild is age 14 or older.