Packaging Your Gifts Carefully: Lifetime Gifts as an Estate Planning Tool

Article excerpt

Estate planning is important to many taxpayers and their advisers. Despite attempts to unify the estate and gift tax structures, good reasons still exist for making lifetime gifts. These gifts can remove future appreciation from an estate.

Example 1: An individual is in the 39.6% marginal income tax bracket. The individual owns $10,000 of property which produces a 10% annual return and a 5% growth rate. If the individual gives the property to her daughter and the daughter holds on to the property until the individual dies in 15 years, the $10,789 increase in the value of the property will have been removed from the individual's estate.

Also, gifts can shift income to lower bracket taxpayers.

Example 2: If the donee in example 1 is in the 15% marginal income tax bracket, $246 of federal income taxes are saved each year on the annual return received on the property. When state income taxes are considered, the difference is even greater.

Gifts can utilize a spouse's unified credit, avoid state inheritance taxes and, if charitable property is involved, provide income tax deductions to the donor. However, the most significant advantage to inter vivos giving is often the simplest; the benefits derived from the gift tax annual exclusion if the gift is structured properly.

The Basics of Annual Gifts

The gift tax annual exclusion has been in the Internal Revenue Code since 1932 and has benefitted many donors, though they may not have realized it. Most Christmas gifts, birthday gifts and the like are excluded from gift taxation because of this exclusion. The first $10,000 in annual gifts to a donee is free of gift tax.[1] This exclusion was placed in the Code to save the IRS the administrative expense of dealing with small gifts. Thus, this exemption often is considered a de minimis provision intended primarily to avoid the burden of taxing simple gifts between family members. However, this exclusion is not limited to small gifts of $10,000 or less; it excludes the first $10,000 of the value of a gift even when large gifts are involved, and is not limited to intra-family transfers. Also, since the exclusion is per donee and renews itself each calendar year, these annual amounts often can add up to large sums.

Example 3: Dr. Mike Mason is concerned with the potential size of his estate. Mason has four children and six grandchildren. If he gives each child and grandchild $10,000 a year, he can reduce his estate by $2,000,000 over 20 years without incurring any tax liability or using up any of his $600,000 unified exemption.[2] Furthermore, since he is married, he and his wife can dispose of a $4,000,000 transfer tax free. This is true whether she owns any interest in the gifted property or not. The Internal Revenue Code's gift splitting provisions will consider her, for gift tax purposes, to own one-half of the property transferred by her husband. Thus, sizable estates can receive substantial benefits from this de minimis rule.

Of course, there are other tax benefits Mason and his family will derive from these transfers. The property will be transferred at today's value, eliminating both gift and estate tax consequences to Mason on future appreciation of the transferred property. Since some children and grandchildren are likely to be in lower tax brackets, a family income tax savings can be realized as well.

Example 4: Sam Milton owns corporate bonds which produce $10,000 of interest income a year. When state and federal income taxes are considered, Sam is in the 44.6% marginal income tax bracket. Sams 22-year old son Mort is in the 17% marginal income tax bracket. If Sam gives the corporate bonds to Mort and uses some of his unified transfer credit, there is no gift tax on the transfer, and a $2,760 annual income tax savings [(.446 -.17) ($10,000)] is effected.

State transfer taxes may be saved as well, because many states have inheritance taxes but not gift taxes. …