ESTATE PLANNING WITH GIFTS
By: Jonathan L. Mate, Spring, 2003
For many years we have had a unified estate and gift tax system. This system treats gifts made during lifetime in excess of the annual exclusion (currently $11,000 per year per person), the same as if they were bequests under a will and were made after death. Since the current exemption from estate and gift tax is $1 million dollars, a person can give away $1 million dollars in gifts during life, with no gift tax consequences.
For several years, estate planners have been recommending to their clients that they use the exemption from gift and estate tax during their lifetime. In other words, if a person could afford to make such a gift without it having an adverse effect on their lifestyle, such a person could give away a total of $1 million to children, grandchildren, or any other beneficiary without incurring any gift tax.
Why is this effective? If such a gift were not made during lifetime, the gift assets would simply continue to grow inside the donor’s estate. The $1 million could grow to be worth $2 million, which at the time of the donor’s death, if exposed to estate tax, could cost his or her heirs $1 million in estate taxes. If the gift of $1 million were made during the donor's lifetime, none of the appreciation would be included in the estate and the appreciation would belong to the beneficiary, free of estate tax.
Although the Federal estate tax exemption is scheduled to increase to $1.5 million in 2004, $2 million in 2006, $3.5 million in 2009 and be repealed in 2010, the gift tax exemption has been frozen at $1 million. All gifts in excess of $1 million will be subject to a gift tax. In 2010, when the estate tax is repealed, the gift tax rate will be equal to the highest income tax rate, which is scheduled to be 35%.
One drawback to gifts is that the recipient acquires the donor’s tax basis of the gift asset. If a donor were to make a gift of General Motors stock currently worth $1 million with a cost basis of $500,000, the recipient takes over the cost basis of the donor; when the stock is sold, the recipient will be taxed on the capital gain. Conversely, if a donor dies owning $1 million in General Motors stock with a cost basis of $500,000, the beneficiary inherits that stock at the value on the decedent’s date of death. The beneficiary acquires what is called a “stepped-up” basis, which permits the beneficiary to use the decedent’s date of death value for the stock as his or her cost, thereby reducing or eliminating the capital gain. It is therefore a critical decision when making lifetime gifts to determine whether an asset has a capital gain which might be erased if that asset were included in the decedent’s estate at death.
It is very common for older people to consider making a gift of a residence to a child or children to protect that asset from claims of creditors resulting from a catastrophic illness. However, if such a transfer is made during lifetime, the rules regarding capital gains apply. If the asset is the personal residence of the donor, upon sale, he or she would be entitled to a $250,000 exclusion from capital gains for an individual or a $500,000 exclusion for a married couple. If the residence is transferred to children who do not use the property as their personal residence, this exclusion is lost.
In light of the foregoing, the overriding question which must be answered before a donor decides to make any of these contemplated gifts is whether the donor’s estate will be subject to estate tax. If it is not, then the advantages of making lifetime gifts may be reduced. However, if a donor’s estate is large enough to be subject to an estate tax, then making gifts of appropriate assets may be warranted.
There are other consequences to be considered in making such gifts, such as protecting the assets from the claims of creditors or whether such gifts will be properly safeguarded by the beneficiaries. In the latter case, there may be a need for a trust or some other vehicle to protect the assets until the beneficiaries are able to manage them.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.
For many years we have had a unified estate and gift tax system. This system treats gifts made during lifetime in excess of the annual exclusion (currently $11,000 per year per person), the same as if they were bequests under a will and were made after death. Since the current exemption from estate and gift tax is $1 million dollars, a person can give away $1 million dollars in gifts during life, with no gift tax consequences.
For several years, estate planners have been recommending to their clients that they use the exemption from gift and estate tax during their lifetime. In other words, if a person could afford to make such a gift without it having an adverse effect on their lifestyle, such a person could give away a total of $1 million to children, grandchildren, or any other beneficiary without incurring any gift tax.
Why is this effective? If such a gift were not made during lifetime, the gift assets would simply continue to grow inside the donor’s estate. The $1 million could grow to be worth $2 million, which at the time of the donor’s death, if exposed to estate tax, could cost his or her heirs $1 million in estate taxes. If the gift of $1 million were made during the donor's lifetime, none of the appreciation would be included in the estate and the appreciation would belong to the beneficiary, free of estate tax.
Although the Federal estate tax exemption is scheduled to increase to $1.5 million in 2004, $2 million in 2006, $3.5 million in 2009 and be repealed in 2010, the gift tax exemption has been frozen at $1 million. All gifts in excess of $1 million will be subject to a gift tax. In 2010, when the estate tax is repealed, the gift tax rate will be equal to the highest income tax rate, which is scheduled to be 35%.
One drawback to gifts is that the recipient acquires the donor’s tax basis of the gift asset. If a donor were to make a gift of General Motors stock currently worth $1 million with a cost basis of $500,000, the recipient takes over the cost basis of the donor; when the stock is sold, the recipient will be taxed on the capital gain. Conversely, if a donor dies owning $1 million in General Motors stock with a cost basis of $500,000, the beneficiary inherits that stock at the value on the decedent’s date of death. The beneficiary acquires what is called a “stepped-up” basis, which permits the beneficiary to use the decedent’s date of death value for the stock as his or her cost, thereby reducing or eliminating the capital gain. It is therefore a critical decision when making lifetime gifts to determine whether an asset has a capital gain which might be erased if that asset were included in the decedent’s estate at death.
It is very common for older people to consider making a gift of a residence to a child or children to protect that asset from claims of creditors resulting from a catastrophic illness. However, if such a transfer is made during lifetime, the rules regarding capital gains apply. If the asset is the personal residence of the donor, upon sale, he or she would be entitled to a $250,000 exclusion from capital gains for an individual or a $500,000 exclusion for a married couple. If the residence is transferred to children who do not use the property as their personal residence, this exclusion is lost.
In light of the foregoing, the overriding question which must be answered before a donor decides to make any of these contemplated gifts is whether the donor’s estate will be subject to estate tax. If it is not, then the advantages of making lifetime gifts may be reduced. However, if a donor’s estate is large enough to be subject to an estate tax, then making gifts of appropriate assets may be warranted.
There are other consequences to be considered in making such gifts, such as protecting the assets from the claims of creditors or whether such gifts will be properly safeguarded by the beneficiaries. In the latter case, there may be a need for a trust or some other vehicle to protect the assets until the beneficiaries are able to manage them.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.
