Two factors make this an especially important year to carefully reconsider the role of gifts in your estate plan. Many of you will find you should make more gifts than initially planned.
One factor is the calendar. The cur-rent estate and gift tax benefits might not be with us for long.
This is a presidential election year. A number of candidates propose reducing the lifetime estate and gift tax exemption and making other increases in estate and gift taxes.
Even if those efforts aren’t successful, the current estate tax benefits expire after 2025. In the current political environment, an extension of those benefits seems unlikely. The other factor is the extended stock market rally. Stock prices have rallied far above what many people anticipated only a few years ago, giving taxpayers more valuable estates than they projected. Because of these factors, you might want to make gifts and move assets out of your estate while the tax-free limits still are high.
There are other reasons to consider making gifts, even if you aren’t in the top 1% whose estates currently will be the only ones hit with estate and gift taxes. Lifetime giving allows you to improve the lives of your loved ones now
and let them learn to manage wealth. You also see how they handle and spend the money, which can provide lessons for how to make future gifts and leave an inheritance.
Giving also can reduce your income taxes and the family’s total tax burden, if you give income-producing assets or those with large capital gains to family members in lower tax brackets.
You can start by making tax-free gifts for education and medical care. Gifts for these purposes are tax free in unlimited amounts when certain conditions are met.
Unlimited education gifts are tax-free when 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 educational institution. The gifts can be made on behalf of any individual, regardless of his or her relationship to you, and for any level of education.
Medical gifts are tax free in unlimited amounts when payments are made directly to a medical care provider for items that would qualify as deductible itemized medical expenses on Schedule A of the income tax return.
These two types of tax-free gifts are in addition to the annual gift tax exclusion amount and don’t count toward your lifetime exemption, both of which I discuss next.
The next way to make tax-free gifts is by using the annual gift tax exclusion. Gifts of up to $15,000 annually per recipient are tax free. There’s no limit to the number of recipients to whom you can make these tax-free annual gifts. A married couple can make the gifts jointly, giving up to $30,000 annually tax free to each recipient.
The amount of the annual exclusion is indexed for inflation but has been at $15,000 for several years. Gifts qualifying for the annual exclusion don’t have to be reported on a gift tax return and don’t count against the lifetime estate and gift tax exclusion. To qualify for the exclusion, a gift has to be complete, meaning there are no strings attached and you legally can’t take back the gift.
Gifts above the annual exclusion still will be tax free but will use the lifetime estate and gift tax exemption, which for 2020 is $11.58 million per person and $23.16 million per married couple. Only after your lifetime
gifts and the value of your estate exceed the lifetime exclusion are gifts or the estate subject to taxes. Many people save the lifetime exemption to maximize the amount applied against the estate. But saving the exemption to use later often isn’t a good idea.
One reason not to wait to use today’s high exemption amount is it might disappear. The current exemption amounts are set to expire after 2025 if Congress doesn’t extend them. In addition, as I mentioned, a number of candidates for president and other offices in 2020 propose reducing the exemption amount before 2026.Another reason not to save the ex-emption is that it could be more useful to you and your family today. Here’s why.
The estate and gift tax are imposed on the value of money or property. You probably anticipate that your home, investments and perhaps other assets are likely to increase in value over time.
Let’s say you have assets that exceed what you need to support your standard of living. When you continue to own them and their values increase, they will use more of your estate tax exemption in the future.
By making gifts of the assets today, you remove more property from your estate and reduce potential estate taxes in the future.
Here’s a simple example. Suppose you own shares of a mutual fund or stock valued at $10 per share today. You could give them to a loved one,
either directly or through a trust, and the shares would be out of your estate. Your lifetime exemption would be reduced by today’s value of the shares.
Now, suppose instead of making a gift, you hold the shares. Next year, they are worth $11 per share. If you make a gift then, more of your lifetime exemption is used to remove the same number of shares from your estate.
Let’s say you hold them until you pass away and they then are worth $20 per share. At that time, twice as much of the exemption is used to pass the same number of shares to the next generation and less of the exemption is available to protect other assets.
The earlier you give appreciating assets, the less of your annual gift tax exclusion and lifetime estate and gift tax exemption are used to transfer that property out of your estate.
It would be even better to make gifts of these assets during a market down-turn. Their value will be down temporarily, so more shares can be moved out of your estate per dollar of the lifetime exemption used.
All the future appreciation is out of your estate. If you can afford to do so, it makes a lot of sense to remove property and its future appreciation from your estate at today’s values instead of at higher future values. That’s especially true if the estate tax exemption is reduced in the future and estates that weren’t taxable under today’s law become taxable in the future.
You can give money or property directly to loved ones, but that’s not a good idea in some situations. You might be concerned the recipient will waste the gift or spend it inappropriately. The loved one might have issues with creditors or substance abuse that put the gift at risk. Or you might want to be sure it is invested and managed well.
In these cases, you could make the gift through a trust and set the trust terms to increase the likelihood your goals will be met.
Some people don’t make gifts because they are concerned that a future market downturn or other unfortunate event might cause them to need the money someday.
Fortunately, there are ways to make gifts that qualify for tax benefits while still retaining some future access to the wealth. Here are two strategies to consider.
Spousal lifetime access trust (SLAT). This is a strategy for married couples. Each spouse establishes an irrevocable trust for the
benefit of the other spouse, their children and perhaps their grand-children. The property in the trusts is excluded from the estate of each spouse for tax purposes. Yet, the couple benefits from the wealth during their lifetimes.
For example, Max Profits establishes a trust for the benefit of his wife Rosie and their children. During her lifetime, Rosie has access to the income and principal of the trust. Max indirectly benefits from that trust, because Rosie spends the income and principal distributed to her for their joint needs.
Sometime after Max creates the trust, Rosie sets up a similar trust for the benefit of Max and their children. Rosie often benefits when Max spends money from that trust. Suppose Rosie is the first to pass away. Her trust is split into separate trusts for the benefit of each child.
Max loses the indirect access he had to the trust and its assets and has access only to the trust Rosie set up for his benefit. When the trusts are created, Max and Rosie need to determine if the surviving spouse would be able to maintain the standard of living on the distributions from only one trust. If not, then each trust should purchase life insurance on the life of the other spouse.
The trust set up for Max’s benefit, for example, would buy life insurance on Rosie’s life. When Rosie
passes away, Max’s trust receives the life insurance benefit. That replaces the distributions from Rosie’s trust Max no longer will have access to receiving.
A SLAT needs to be prepared by an experienced estate planner. For the strategy to work, key provisions of trust and insurance laws need to be complied with.
A variation known as the reversible SLAT can be used when the SLAT isn’t viable.
In the reversible SLAT, Max would transfer money or property to a trust for the benefit of Rosie and their children. The trust would buy a permanent, cash value life insurance policy on Max’s life. If Max isn’t
married, the trust benefits only his children.
The trust agreement permits the trustee to make loans to Max, as long as Max provides a promissory note for each loan that bears the prevailing interest rate and is secured by a pledge against Max’s assets.
The trustee can take tax-free loans against the life insurance policy and lend that money to Max. These loans supplement the cash provided by Max’s other assets and income.
The amount of money Max can borrow is limited by the amount the trust can borrow against the policy’s cash value without causing the policy to lapse.
After Max passes away, the loans to the trust are paid using assets from Max’s estate. Since the property is used to pay a debt, it isn’t included in the taxable estate and essentially is transferred to the trust, free of estate and gift taxes.
The trust also receives the life insurance benefits, minus the out-standing loans and accumulated interest. These are paid to Rosie and the children or held in the trust for future distributions.
This is another strategy that requires careful work from an experienced estate planner.