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Planned
Gifting to Children and Grandchildren
By: James Lange, JD, CPA
As you are probably
aware, our law firm prepares retirement and estate plans for individuals
with significant retirement plan accumulations. We also draft sophisticated
wills and integrated beneficiary designations for IRAs and retirement
plans. In addition, we give Roth IRA conversion advice. Let's not,
however, forget the basics.
One of the easiest
and most effective tools for reducing estate taxes is a systematic
program of making annual gifts to children and/or grandchildren.
Gifts will reduce the amount of your gross estate that is subject
to federal tax by the amount of the gift plus the future appreciation
of the gifted asset's value. Gifts can also serve a function in
your income tax planning by shifting income-producing or appreciated
property to others who are in a lower tax bracket. With estate tax
rates as high as 55 percent, and with income tax rates ranging from
15 percent to 39.6 percent, planned gifting can yield significant
benefits.
While many gifts
are subject to gift taxation, you can give away up to $10,000 per
recipient per year free of gift tax. These gifts also do not reduce
the $650,000 exemption amount that you can pass free of estate tax.
There is a great deal of flexibility in the types of property that
can be transferred. Qualifying gifts can be money, property such
as stocks or bonds, or even a life insurance policy, as long as
the recipient gets the present right to possess or use the property.
The gift may be in trust if the terms of the trust give the recipient
the immediate right to the property or income from the property.
If the recipient is a minor, the gift may be made to a custodian
or legally appointed guardian of the minor's property under your
state's version of the Uniform Gift to Minors' Act. If the recipient
is a child under 14, however, income from the property may be taxed
at the parent's marginal rate.
You can give
up to $20,000 per recipient per year if you are married, and your
spouse consents to "split" your gifts. This is useful
for spouses who do not own an equal amount of property. The spouse
with less property can consent to gifts made by the wealthier spouse,
thereby effectively doubling the amount that the wealthier spouse
can give away tax-free. To take advantage of "gift splitting,"
both spouses must be U.S. citizens or residents. The consent must
be given on a gift tax return -- therefore, a return must be filed
even if no gift tax is due. A short form gift tax return is available.
For citizens who want to make a $20,000 gift to a beneficiary, I
usually recommend writing the check for the gift from a jointly
owned account to avoid the need to file a gift tax return.
Let's do a simple
example of the long-term estate tax savings of a simple gifting
program. Assume that Mr. & Mrs. Affluent have two children.
Based on their assets and other income, they feel they can afford
to make gifts of $20,000 per year to each of their two
children. They plan on making gifts the rest of their lives unless
their circumstances change, and they feel they can no longer afford
to make the gifts. Let's also assume they make these gifts for 20
years and die. If they had not made the gifts, the value of the
gifts and the appreciation on the gifts would have been in their
estate and taxed at 50% for federal estate tax purposes. Using a
6% rate of return, the total value of the gifts was $1,471,424 at
their death. The estate-tax savings resulting from the gifting program
was $735,712. It is likely that this simple gifting technique saved
the family more money in estate taxes than all of the documents
an attorney could draft. Making the appropriate financial moves,
whether they be a gift or making a Roth IRA conversion or even making
a gift that your children will use to fund a Roth IRA or Roth IRA
conversion will reduce estate taxes. We encourage the proper drafting
of appropriate documents as well as taking other
suitable financial steps that may include a gifting program for
clients who can afford to make gifts.
There are a
variety of gifting techniques. For example, creating an irrevocable
trust funded by a life insurance policy is nothing more than a leveraged
gift. In addition, grantor retained interest trusts (such as GRATS
or GRUTS), family limited partnerships and a variety of other techniques
are often useful and advisable. Most of these and other estate-planning
techniques are only a variation of a gift.
One important
thing to remember when you make a gift is that the recipient receives
your tax basis in the property. This means that if the recipient
sells the property, any gain on the sale will be measured using
what you paid for the property, not what the property was worth
when the recipient received it. In contrast, if property is transferred
to another through your estate, the recipient can use the value
of the property at that time in measuring any gain on the sale of
the property. Consequently, choosing the right property to achieve
your goals is an important aspect of any gift-giving program.
Another way
to further the financial security of others without incurring gift
tax is by payment of medical and educational expenses. You can pay
an unlimited amount for these expenses on behalf of family members
as long as the payments are made directly to the medical services
provider or educational institution. The medical expenses must not
be reimbursed by insurance. (One Word of Caution: If you pay medical
or educational expenses for a grandchild, the child's parents may
realize taxable income if the parents are obligated by law to pay
these expenses.)
If used properly,
a program of systematic giving can benefit everyone involved. If
your situation is such that you cannot afford gifts on a systematic
basis, consider making gifts on an "as needed" basis.
Keep in mind, however, that every year you fail to make a gift,
you give up your right to utilize your $20,000 per year exclusion
for that year. If there are sufficient assets, it is preferable
to begin a systematic gifting program and stop the program (if necessary),
rather than waiting to start a gifting program sometime in the future.
The opportunities lost while waiting for a gifting plan to become
more convenient can never be recaptured.
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