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Gifting Strategies in 2011 and 2012

New York State Bar Association Journal

by Stanley E. Bulua and A. Mitchell Greene

As people accumulate wealth and advance in age, a well-planned gifting program to children and grandchildren can help achieve family objectives as well as minimize estate taxes that would otherwise be due on death. In determining whether to make gifts to children and grandchildren, it is important to determine if the donor has adequate resources after making the gift to meet his continuing financial and lifestyle requirements. Once the financial situation of the donor is determined, a gifting program can be implemented to transfer “surplus” wealth using a variety of gifting strategies described below.

Annual Exclusion Gifts:
Each person can gift annually $13,000 (indexed to inflation) in value of assets per recipient. There is no limitation on the number of recipients (donees) but the gift must be one of a present interest.  Gifts that qualify for the annual exclusion remove assets from the donor’s estate for estate tax purposes and, over the course of many years, can result in significant tax savings.  For example, assume four (4) donees receive annual exclusions gifts for a period of 15 years and therefore the aggregate value of the gifts is $780,000. Assuming a combined federal and state estate tax rate of forty-five percent (45%), and without regard to future appreciation of the assets, the estate tax savings would be $351,000. If both husband and wife make equivalent gifts or split gifts, the tax savings would be doubled. Gift splitting allows either a husband or wife to treat one-half of any gift made by one of them to a third party as if made one-half by each. The only disadvantage to gifting is that the donee generally takes the donor’s basis in the gifted assets whereas if the asset is left in the donor’s estate, it will generally receive a new stepped-up basis upon death so that any appreciation during lifetime is eliminated from capital gains taxation. Since the tax rate on capital gains is lower than the estate tax rate and since a tax on sale is only imposed when a sale occurs, the loss of the stepped-up basis is typically outweighed by the estate tax advantages.

Gifts for Medical and Educational Expenses
Payments that are made directly to a medical provider or an educational institution for the benefit of family members are not treated as gifts and don’t use up the payor’s annual exclusion or lifetime exemption. These payments can be made on behalf of children, grandchildren or any other family members.

Section 529 plans are also available to fund expenses for higher education. Contributions under these plans use the donor’s annual exclusions and can be used to front-load five years worth of annual exclusions gifts with a gift of $65,000 (or $130,000, if husband and wife split gifts). If this is done, then no additional annual exclusion gifts can be made over the 5-year period commencing with the year in which the Section 529 plan is funded. With 529 plans, no income tax is imposed on earnings within the plan and distributions from the plan are not subject to income tax, as long as the proceeds are used for higher education expenses. Furthermore, many states provide for state income tax benefits with respect to funds contributed to a 529 plan maintained and sponsored by that state.

Lifetime Exemption Gifts
The lifetime exemption is an amount that an individual can gift during lifetime or leave to his heirs upon death that is not subject to federal gift or estate tax. As a result of the changes to the gift and estate tax law made by the 2010 Tax Act, the federal lifetime exemption has been increased to $5 million per person, thereby permitting a husband and wife to collectively gift up to $10 million dollars during their lifetimes without the imposition of a gift tax. The 2010 Tax Act will sunset on December 31, 2012, and there is no assurance that the $5 million lifetime exemption for gifts and estates will continue beyond that date. The benefits of making large gifts now for individuals who have large estates are as follows:

  1. Gifting appreciating assets freezes the value at which the asset will be taxed in an individual’s estate. For example, if stock currently valued at $2 million is gifted and has appreciated to $3 million when the donor dies, then the $1 million in appreciation and the income earned thereon during the interim (if not spent) will be removed from the donor’s estate. Assuming a forty-five percent (45%)  combined federal and state estate tax rate, estate tax savings of $450,000 will have been achieved:
  2. New York does not have a gift tax although it does have an estate tax. Making gifts during lifetime removes assets from the New York taxable estate which is taxed at rates ranging from six percent (6%) to sixteen percent (16%).
  3. Gifts of interests in entities, i.e., corporations, partnership and LLCs, can be discounted due to the lack of control and lack of liquidity that are inherent in such interests. For example, a gift of a twenty percent (20%) interest in a limited liability company that holds real estate worth $10 million might be entitled to a discount ranging between twenty percent (20%) and thirty-five percent (35%).  Assuming a discount of thirty-five (35%),  the amount of the reportable gift would be $1,300,000.   Congress has previously considered restricting the availability of such discounts and there is no assurance that discounted gifts will continue into the future;
  4. Many gifting strategies which are beyond the purview of this article involve leveraging interest rates by outperforming the prescribed IRS interest rate assumptions which are published on a monthly basis. Although today’s low-interest rate environment is conducive to such strategies, there is no guarantee that the current low-interest rate environment will continue indefinitely;
  5. Gifts to grantor trusts, i.e., trusts in which the creator of the trust is taxed on all of the income generated by the trust investments, are disregarded for income tax purposes. Accordingly, the grantor is permitted to pay the income taxes while the trust is permitted to grow in value without being burdened by income taxes.  The funding of such a trust followed by the donor’s payment of the income tax on the trust investments, which is equivalent to a tax-free gift, has been approved by the IRS; and
  6. Gift to spousal access trusts can be used to achieve many of the benefits described above in situations where the donor has a stable marriage and is concerned about his ability to access the funds in the event of an unexpected financial need. In this situation, the donor makes a taxable gift to a trust in which his spouse is a discretionary beneficiary, with principal passing to the children or grandchildren upon the death of the spouse. For donors who are not comfortable with complete lack of access to the gifted assets, these gifts provide a viable alternative.

Reprinted with permission from: New York State Bar Association Journal, July/August 2011, Vol. 83, No. 6, published by the New York State Bar Association, One Elk Street, Albany, NY 12207.