Basic Gifting Strategies

January 14, 2010

Review these basic gifting strategies that should not be overlooked in your estate plan.

The most obvious way to avoid or reduce the impact of estate taxes is to give away property during your lifetime. Not only is the gifted property removed from your estate, but all the income and appreciation attributable to such property is also removed.

The following are some very basic gift planning techniques, which are sometimes overlooked by taxpayers, that could significantly reduce the value of your estate, without the imposition of Gift or Estate Taxes.

Annual Exclusion Gifts

Individuals are allowed to give gifts of up to $13,000/per recipient each year (indexed for inflation in $1,000 increments), and these gifts are all covered under this annual exclusion.
In general, a married couple can elect to treat a gift as if each gave half, thus doubling the benefit and making it possible to give their recipients $26,000 annually without any gift tax consequences. (This election applies to all gifts made by both spouses during the year to third parties). For example, if a married couple has three married children and six grandchildren, they can gift to them a total of $312,000 a year ($26,000 x 12 recipients) of annual exclusion gifts.

In order to qualify for the annual exclusion gifts must be of a ‘present interest’ versus gifts of a ‘future interest.’ This means the recipient must be able to use the assets immediately versus restricting their ‘present use.’ In general, putting the assets in a trust for future transfer may not qualify for the annual exclusion.

However, there are gifting methods available that will allow for transfers into trusts (qualifying for the gift tax exclusion). One method that is often used to qualify gifts into a trust for the annual gift tax exclusion is the use of ‘Crummey Trusts.’ In a Crummey Trust, the beneficiary has the right to withdraw a certain amount out of contributions made to the trust that year. (Generally, the withdrawal amount is smaller than the $13,000 annual exclusion or the amount of the gifts made by the donor that year.) If the beneficiary doesn’t withdraw this amount within a certain period of time (typically, 30 days after the gift is made and the beneficiary is given notice of the right to withdraw), then he/she loses the right to demand withdrawal at a later date. These assets (including the income and appreciation) remain in the trust and can be distributed at a later date pursuant to the provisions in the trust agreement.

Direct Payment of Educational or Medical Costs

In addition to the annual gift tax exclusion, you can make unlimited individual gifts by paying someone’s tuition (for any level of schooling) or medical costs, provided you make the payments directly to the educational institution or medical provider.

College Savings Plans

A gift to a Section 529 College Savings Plan is also available as a means of transferring assets free of gift tax. A donor can contribute in the initial year (year of funding) up to five times the annual exclusion amount and make an election to treat the gift as if it were made pro rata over five years. Thus in 2010, a donor could contribute $65,000 ($13,000 x 5 years) to a 529 Plan for a beneficiary and make the five-year election to treat the gift as if it were made pro rata over the years 2010 to 2015, thus qualifying the entire gift for the annual gift tax exclusion. However, the donor would not be able to make any additional annual exclusion gifts to the beneficiary in those years (except to the extent of any future inflation adjustment to the annual exclusion). A married couple can make a contribution of up to $130,000 per beneficiary to a 529 Plan in 2010 and qualify for the annual exclusion.

Separate 529 Plans can be created and funded for as many individuals as a donor wishes. Gifts into a Section 529 Plan provide substantial income tax savings as well, since neither the Plan nor the beneficiary pays income taxes on the distributions.

Lifetime Gift Tax Exclusion

In addition to the $13,000 annual exclusion gifts and gifts for educational or medical costs, you can give away $1 million (as of 2010) during your lifetime without paying gift taxes. For a married couple, up to $2 million can be given away. However, these gifts reduce the estate tax exemption available at your death dollar for dollar.

Although Congress was unable to pass legislation in 2009, it will likely act to reinstate the estate tax and may attempt to make this tax retroactive to January 1, 2010.It is not known, however if Congress has the power to impose these taxes retroactively, or whether Congress will reinstate the tax at the 2009 rates or at a different rate.

It is often recommended to make gifts of the exclusion amount sooner rather than later, because all the income and appreciation is out of your estate. If there is a concern that significant funds should not be paid directly to the donee, a trust is often used.

Taxable Gifts

There also may be a benefit to making taxable gifts during your lifetime. A taxable gift generally occurs when the taxpayer exceeds his $1 million lifetime gift tax exclusion. However there are a number of issues that should be addressed before making taxable gifts. Due to the uncertainty of the estate tax, taxable gifts may not be advisable at this time.

Intentionally Defective Grantor Trust

A major incentive for making lifetime gifts is the ability to avoid including future appreciation of, and income from, the transferred property in the donor’s estate. After the transfer, the donee (recipient of the gift) is generally responsible for paying taxes on the income and appreciation attributable to the transferred property. It may be possible, however, to structure the gift so that the donor (transferor of the assets) rather than the recipient is responsible for paying the income taxes.

Why would the donor want to pay taxes on income from property he or she no longer owns? A transfer to a properly structured Intentionally Defective Grantor Trust (IDGT) is considered a completed transfer for estate and gift tax purposes, but incomplete for income tax purposes. Therefore, an IDGT would not be included in the donor’s estate upon his or her death, yet it would be considered a grantor trust for income tax purposes. As a grantor trust, the donor is taxed currently on the trust income. By relieving the recipient of the responsibility of paying the income taxes attributable to the income earned by the trust, the donor, in effect, is making additional gifts to the trust, free of any gift tax. This can result in substantial savings. IDGTs are becoming more and more popular, and when combined with other planning techniques can result in significant estate and gift tax savings.

Valuation Discounts

Utilizing one’s gift tax exemptions and combining them with valuation discounts can also be a very effective tool in transferring greater wealth between generations while also minimizing estate taxes. These discounts are often used when transferring interests in closely held entities, partnership interests, and fractional interests in property.

When using discounts, it is strongly advisable that a professional appraiser be engaged who will determine the value of the underlying assets (including real estate, businesses interests, investments, tangible assets, etc.). The appraiser will then determine a specific discount percentage based on factors such as lack of control (minority discounts) or lack of a market for the transferred assets (marketability discounts). The rationale for a minority discount is that a willing buyer would pay less for an asset in which he or she would not control management, the right to receive income, or the right to sell the underlying assets. Marketability discounts generally apply when there is a limited market of potential buyers for the transferred interest (as compared to the underlying assets as a whole).

There are a number of estate planning strategies that utilize the benefits associated with valuation discounts.

Although the aforementioned gifting techniques are “basic” in nature, they can be used as a cornerstone for establishing more sophisticated and more creative ways of transferring assets free of estate and gift taxes. It is recommended that you contact your CPA and attorney to discuss your objectives and goals.

Eisner & Lubin LLP would be happy to discuss these and other strategies to facilitate the smooth transition of wealth from generation to generation.

This article was written by Al LaRosa, CPA, partner, Eisner & Lubin LLP. La Rosa joined E&L in 1983 and became a partner in the trust and estate practice in 1993. He helps clients plan their estates to facilitate a smooth transfer of wealth and is heavily involved in charitable tax planning.

Our firm provides this information for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Tax articles are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.