One of the time-tested strategies in estate planning is reducing the overall size of your estate by gifting. However, when and how you gift can be just as important as whether you gift.
Each person can give up to $11,000 each year to as many people as they want for any reason, the so-called “annual exclusion.” By gifting early in the year rather than late in the year (like Christmas), you are effectively giving not only the $11,000 but also whatever the $11,000 earns during the year. Simply writing the check is not enough. If you write a check to each of your three children and seven grandchildren but they do not cash them, the gift is not complete. If something happens to you before the checks are cashed, the entire $110,000 ($11,000 for each of the ten recipients) is still taxed in your estate. Therefore, it is important to make sure that your loved ones cash the checks as quickly as possible. You can also make the gift using a cashier’s check or wire transfer to avoid this problem.
You can also gift an unlimited amount of money for anyone’s tuition or medical expenses. This transfer must be made directly to the educational institution or the medical care provider. It can be a great way to transfer a large sum, without being subject to gift or estate tax. For example, if your grandson is attending a private high school, you can pay the tuition and that will not be considered a gift to your child or your grandchild. You simply pay the tuition directly to the high school. Similarly, if your niece has medical bills not covered by her insurance, you can pay those bills and it will not be considered a gift by you. As tuition and medical expenses can be quite significant, this can be a very powerful way to transfer money to those you love without incurring a gift or estate tax.
You can give minority or fractional interests in property and get a discount, enabling you to give even more. For example, imagine you own a closely-held business worth $100,000. How much is a 20% interest in the company worth? Would you pay $20,000? Probably not because a 20% interest has no control over the operations. A 20% interest may only be worth $11,000. So, you effectively get $20,000 worth of the business out of your estate and to your loved ones by using your $11,000 annual exclusion. You could do fractional gifting with real estate, too. For example, if you had farmland worth $100,000, a 15% undivided interest might only be worth $11,000. Again, you can give more by gifting fractional interests.
You should also consider the income tax “basis” of the property you choose to gift. “Basis” refers to the benchmark of the property for income tax purposes, typically your purchase price. When you sell at higher than your basis, you have a gain. When you sell at lower than your basis, you have a loss. When you gift property, the recipient gets the lower of your basis in the property or the fair market value of the property. So, if you have a loss in the property, that loss disappears by gifting. It would be better to sell loss assets and harvest the losses and gift the cash. The income tax basis of property in your estate is “stepped up” to fair market value when you die. Accordingly, it usually does not make sense to give away property that has appreciated greatly, especially if your life expectancy is short. For example, imagine you own Microsoft stock you purchased for $1,000 and it is now worth $50,000. If you give the stock to your son, he will have your $1,000 basis. If he sells the stock for $60,000, he will have a taxable gain of $59,000.
Finally, how will gifting assets to your descendants change your relationship with them and their relationships with each other? Will your granddaughter squander the assets if you give to her outright? Will your son resent you because your granddaughter is financially less dependent on him? It is important to consider these personal issues, not just the financial issues.
Gifting is not as simple as it looks. There are many issues which come into play in deciding how and when to gift assets. A qualified attorney who specializes in estate planning can help you design a gifting strategy that can best meet your personal and financial goals.
Mr. Ronald “Chip” Morrison, Jr. is a member of the American Academy of Estate Planning Attorneys and has been engaged in the practice of estate law for the last 16 years. He has experience in both simple and complex estate matters and can prepare an estate plan for you that achieves your goals of passing your assets to whom you wish. For more information or to attend an upcoming seminar, please call our office at (504) 831-2348, or contact us through our website.