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Felhaber, Larson, Fenlon & Vogt
Felhaber, Larson, Fenlon & VogtFelhaber, Larson, Fenlon & Vogt

April 13, 2011

Articles

Lifetime Gifts Are More Important Than Ever

Recent tax law changes have created an unprecedented opportunity for affluent taxpayers to remove substantial amounts of wealth from their estates through lifetime gifts. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 increased the gift and estate tax exemptions to $5 million, and reduced the top rate for these taxes to 35%, but for 2011 and 2012 only.

It’s uncertain whether Congress will make the $5 million exemption and 35% rate permanent, allow them to return to levels prescribed by pre- 2001 tax law in 2013 or take some other action. So if you have the ability to make large gifts (either outright or using trusts or other estate planning vehicles), doing so this year and next may be beneficial. Let’s take a closer look at how to make the most of lifetime gifts.

Maximize Nontaxable Gifts

As you consider the opportunities the $5 million exemption provides, don’t overlook the tax-saving power of annual exclusion gifts and direct payments of tuition and medical expenses. These are true “nontaxable gifts” that can’t be exposed to gift or estate taxes.

Gifts within the $5 million exemption, on the other hand, are still considered “taxable.” So, for example, they’re subject to the “three-year rule,” which provides that certain assets transferred within three years before death are included in the deceased’s taxable estate.

Also, keep in mind that the $5 million exemption is “unified” with the estate tax exemption, meaning that it covers up to $5 million in combined lifetime gifts and bequests at death. Thus, if you make $2 million in lifetime gifts, only $3 million will be left to protect your assets from estate taxes. Or, if the estate tax exemption goes back to $1 million in 2013 as scheduled and you die after 2012, no exemption will be left.

For these reasons, consider maxing out your annual exclusion gifts and direct payments of tuition and medical expenses before making any “taxable” gifts. Nontaxable gifts can be deceptively effective.

Currently, the annual exclusion is $13,000 per recipient ($26,000 for gifts you split with your spouse). Let’s say you and your spouse have three married children and six grandchildren. Each year, you give $26,000 to each child, each of their spouses, and each grandchild. You also pay $20,000 in tuition for each grandchild. That’s a total of $432,000 per year in tax-free transfers without tapping your $5 million exemption.

Take Advantage of the $5 Million Exemption

If you have a large estate, consider making lifetime gifts to take advantage of your $5 million exemption this year and next. Depending on your situation, and your feeling about the likelihood that gift and estate tax rates and exemptions will be reinstated at the pre-2001 levels in 2013, you might even consider making taxable gifts in excess of your available exemption. That way you’ll be able to leverage the lower 35% tax rate before it potentially increases to 55% in 2013.

Even if Congress extends the current exemptions and rates, making gifts sooner rather than later can be a good strategy because it removes all future appreciation on the gifted assets from your estate. Remember, though, that assets transferred by gifts aren’t entitled to a “stepped-up basis.” So be sure to weigh the potential impact of capital gains taxes your heirs will have to pay if they sell the assets against the gift and estate tax savings.

Also, be aware of a potential “clawback” issue that may arise because of the way estate taxes are calculated under the unified system. Some people fear that, if the estate tax exemption shrinks to $1 million by the time someone dies, any lifetime gifts in excess of that amount (even if they were made in reliance on the $5 million exemption) may be “clawed back” into the person’s estate and subject to estate tax (possibly at the 55% rate).

Whether clawbacks are a real concern (many experts argue that they’re not), lifetime gifts still offer significant benefits because, even if the date-of-gift value is later subject to estate tax, the post–date-of-gift appreciation is removed from your estate. And if the clawback issue doesn’t materialize, you’ll have significantly reduced your taxable estate — and the associated estate tax liability.

Look at the Big Picture

Lifetime gifting can be an effective strategy to remove large sums of wealth from your estate, but it’s important to look at the big picture. Don’t make decisions on gifts based on tax savings alone. Also consider nontax issues, such as the gift’s impact on the recipient and the sufficiency of your remaining resources to finance a comfortable retirement.

Please contact any of the Felhaber Estate Planning attorneys if you have questions about whether you are covered.          

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