It’s gift giving season, at least it is for those who want to make shrewd income tax and estate planning moves. While most people don’t make annual estate planning gifts at all and those that do make them in December, the first part of the year is the best time to make tax-wise gifts.
Making gifts now ensures that they are out of your estate for the entire year. If you give property that increases in value during the year, you make a larger tax-free gift by giving now before the appreciation occurs. That’s smart estate planning. And any income from the cash or property is off your income tax return for the entire year. So if you don’t need the income or property, make the gifts now.
Here are some other ways to increase the benefits of your annual gift giving.
Be generous. You know that you can give up to $10,000 annually to anyone without paying gifts taxes ($20,000 for married couples giving jointly). That’s the limit most people give. But there are reasons you might not want to stop there if you don’t need the money or property to maintain your lifestyle.
You have a $675,000 lifetime estate and gift tax credit as of Jan. 1, 2000. (The amount will gradually increase to $1 million by 2006.) This can eliminate gift taxes during your lifetime by that amount. That means if you give someone more than the $10,000 tax-free amount during the year, the lifetime credit eliminates gift taxes until the total “excess” gifts during your lifetime equal $675,000.
For most people, it is better to use the $675,000 exclusion early with gifts than to wait for it to shelter their estates from taxes.
Though inflation is low, it still erodes the value of the $675,000 credit. After 10 years at 3% inflation you’ll need a credit of over $900,000 to get the same benefit as the $675,000 credit today. Here’s another way to look at it. Suppose you have stock worth $675,000 that you don’t need. You can give it away now, use up the credit, and have it out of your estate. But if you hold the stock and it appreciates at 10% annually for 10 years, it will be worth over $1.7 million. It would cost your estate a lot of tax dollars to get all of that that stock to your heirs. If you give the stock before it appreciates, then the gain is transferred to your heirs without any estate or gift taxes.
The same strategy applies even after you have used up the entire lifetime credit. If you won’t need the property to maintain your lifestyle and can afford the gift taxes, consider giving more now and paying the gift taxes. Otherwise, as the property appreciates, your estate increases. The estate taxes on that property will be much higher in the future than gift taxes today.
That’s why it is cheaper in the long run, if you don’t need the property to maintain you lifestyle, to give it early. If you don’t want to give your heirs complete control of the property now, you can put it in a trust. That gets the stock out of your estate and ensures it is managed until your heirs are ready to handle it. You can set rules in the trust for when the heirs get the income and principal.
Give property, not cash. Property can appreciate or generate income. But cash tends to be spent. If your goal is to help your heirs achieve financial independence, then you probably want to give property that should appreciate or generate income or both. But if you want to increase your heirs lifestyle now, you can give cash that they spend.
Giving property also lets you pass a tax bill to someone else in the family, perhaps someone in a lower tax bracket. Sell an asset at a gain, and you’ll owe capital gains taxes. If you give the property, there are no capital gains taxes. The donee takes the same tax basis you had. If the donee sells, he or she pays taxes at his or her capital gains tax rate. (The potential tax bill also can discourage donees from cashing out the property.) If they do sell, when they are in a lower tax bracket than you, the family has a lower tax bill.
Don’t give upkeep. Some people give gifts of property that come with a lot of annual costs. Expensive cars, homes, boats, and other assets are nice. They can give your heirs a lifestyle they couldn’t earn on their own. But make sure your heirs have the income to maintain them properly without cutting back their lifestyles.
Don’t give losers. It is tempting to give investment property that has declined in value instead of selling it, especially if you can theorize why it might turn around. But you are better off selling the property and taking the loss deduction on your own tax return. Then you have several options. Give the cash proceeds from the sale. Or give other property. Or wait more than 30 days, purchase the asset back, and give that to the heirs. You’ll have the tax deduction, and your heirs will have the property.
Give education. The tax law encourages education gifts by allowing unlimited tax-free for education expenses. The payments must be made directly to the education institution and must be for tuition and direct education costs, not room and board, and similar costs.
Report your gifts. If you report and properly disclose gifts on a gift tax return, the statute of limitations starts running. The IRS cannot go to your estate years later, revalue the gifts, and adjust the estate tax. But you must fully disclose the gift. This is important if you used a family limited partnership or some other strategy to get a valuation discount on the property. If you don’t disclose the gift and the strategy, then the statute of limitations doesn’t start. Be sure you work with an accountant or attorney to get a proper gift tax return filed.