Attorney & Counselor at Law
ROBERT M PHILLIPS
The expression "when life gives you lemons, make lemonade" has particular meaning to an estate planner when considered in the context of today's depressed markets and the general world-wide economic malaise. In fact, the current economic environment provides many estate planning "silver linings" that savvy families are taking advantage of today, while these opportunities last. As discussed in this article, with depressed asset values and interest rates at record lows, from an estate planning point of view it is an unusually attractive time to make gifts to your children, grandchildren or other non-charitable beneficiaries.
Gifting as an Estate Planning Strategy
Under current tax law, assets that you transfer to others for no consideration are subject to a federal "transfer tax." If you transfer these assets during your lifetime, the transfer tax is called a "gift tax." If you transfer these assets at your death, the transfer tax is called an "estate tax." Each tax is imposed on the value of the assets transferred. Thus, the larger the value of the assets transferred, the greater the tax. Conversely, the lower the value of the assets transferred, the smaller the tax. And, if the value of the assets transferred is so low as to fall under certain thresholds, there is no transfer tax.
It is this last objective that forms the basis for all tax-reducing estate planning and that clients and estate planners seek-that is, reduce the value of the assets transferred at death and the transfer taxes will also be reduced, or possibly eliminated! By making lifetime gifts of assets, the gifted assets will not be included in the donor's estate at the donor's death and the estate tax will, by definition, be smaller (or none).
There are limits, however, both tax-wise and economically, to the value of assets that you can gift to others. To reduce the possibility, and opportunity, of taxpayers completely avoiding estate taxes at death (by giving away all, or most, of their assets during their lifetime) the tax code imposes a "gift tax" on every asset, including cash, that one gives away during one's lifetime. Under these laws, that $50 birthday check that you mailed to your nephew would be subject to the federal gift tax were it not for an "annual gift tax exclusion" that requires the IRS to ignore taxing "small" gifts.
It was not generosity on the part of the Congress or the IRS that prompted this exclusion. Rather is was mere practicality. Can you imagine the IRS trying to tax all of these kinds of small gifts? When originally instituted, this exclusion was $3,000 per donee per year. As of January 1, 2009, the exclusion has increased to $13,000 per donee per year. To qualify for the exclusion, the gift must be a gift of a "present interest" which, generally means the donee must actually receive, or have the opportunity to receive, the gift during this year.
For example, a married couple with three children could gift a total of $78,000 in assets to their children (by the husband and wife each making a $13,000 gift to each of their children) this year without any requirement to report the gift to the IRS or pay any gift taxes.
If, on the other hand, gifts to any person in a given year exceed the annual gift tax exclusion, those gifts will appear on the IRS radar because a gift tax return is now required and there may be gift tax payable. However, the tax laws allow each of us to make a total of $1 million in gifts exceeding the annual exclusion amounts during our entire lifetime, gift tax free. Once again, this is not an example of benevolence or generosity by the Congress or IRS as these tax-free lifetime gifts (in excess of the annual exclusion amounts) will reduce the value of assets, dollar-for-dollar, that are allowed by the tax code to be transferred tax free at death.
There still is an advantage to making such gifts now (as compared to the same gift made at death) in that the growth, or appreciation in value, of the asset after the gift is made during your remaining lifetime will not be included in your taxable estate at death. If you hold the asset until you die, the full appreciated value of the asset will be subject to tax. This strategy of transferring an asset today, at today's value, to your intended beneficiaries, and thus avoiding all of the appreciation of the asset being taxed to your estate at your death, is at the crux of why today's economic environment provides a good opportunity for making gifts.
Of course, all lifetime gifting is premised on the fact that the donor can and is willing to make gifts during his or her lifetime. If the assets are needed by the donor during the donor's lifetime, outright gifting may not be a viable strategy. In those situations, gifting may still appropriate but techniques other than "outright gifts" may apply. If it is practicable, making lifetime gifts that are not subject to gift tax should be a primary objective, among others, of all estate plans.
Two facts make gifting in today's economic environment a good strategy: First, as of January 1, 2009, the annual gift tax exclusion amount is larger than it has ever been, thus permitting larger tax-free gifts. And secondly, with the value of many asset classes (securities, real estate, etc.) being lower than in recent times, larger amounts of gifts of those asset classes can be transferred, tax-free, today.
Outright Gifts of Depressed Assets
Consider Edward, who owns 1000 shares of Widget, Inc.. In 2007 Widget traded at around $25 a share. Today, the market price of Widget has dropped to $13 per share. Edward could gift all 1,000 shares of Widget to his daughter today and not be required to file a gift tax return or pay any gift tax. Edward believes that eventually Widget will recover its share price and that by making the gift today he will be able to transfer more shares to his daughter and eliminate all of the expected growth in the value of the holdings from his taxable estate. This strategy will apply to gifts of all asset classes that have declined in value, or that one expects to increase in value in the future.
Custodial Gifts to a Minor
If Edward's daughter were a minor, she could not hold and manage the shares in her own name. Instead Edward would need to transfer ownership of the shares to a Uniform Transfer to Minors Act (UTMA) custodial account. Edward should not be the custodian of this account. Under current tax laws, if Edward were both the donor and custodian of the assets, the assets would be included in his taxable estate at his death! This would defeat one of the major objectives of transferring the shares to his daughter and should be avoided.
A recognized disadvantage to transferring assets to a custodial account is that upon attaining twenty-one years of age the assets must be conveyed outright to the child. To avoid this, Edward could use a trust.
Gifts of Depressed Assets in Trust
If Edward's daughter were a minor, or if for any other reason Edward wanted to transfer stock to her but wanted did not want her to have control of the shares immediately upon the gift, Edward could establish a trust and transfer the shares to the trust for her sole benefit. Edward would not be the trustee of the trust, but could control who is the trustee. The value of the shares transferred would still be determined by the value at the time of the transfer (i.e., today's depressed value) permitting more shares to be transferred. If, when and how his daughter receives income and the principal of the trust would be determined by Edward at the time the trust is created and included in the written trust agreement that established the trust.
A disadvantage to making annual exclusion gifts to a trust is that, as noted earlier, in order for these gifts to avoid being subject to gift tax, they must be gifts of a "present interest." A gift into a trust, even a trust solely for the benefit of a single beneficiary, generally does not qualify for such an exclusion. However, by making each gift to the trust subject to so-called "Crummey" powers (simply stated an unrestricted right of withdrawal by the beneficiary for a limited period of time), the gifts can qualify as gifts of a present interest and not be subject to gift taxation.
Gifts in Trust of "Needed" Assets
Suppose Edward wants to give his daughter stock, and take advantage of today's depressed prices so he can give her more shares, but Edward has been enjoying the regular dividend distribution of the stock and decides that he needs keep the income for himself. In this situation, instead of giving the shares outright to his daughter, or to a trust solely for the benefit of his daughter, Edward decides to give the shares to a trust that is designed so that for a specified term of years Edward retains and will receive all of the income of the trust. At the end of the term of years, the shares can then pass to his daughter. If the shares have appreciated in value, Edward has been successful in eventually transferring the shares to his daughter at today's market price, thus avoid transfer taxes on all of the growth in value of the shares while they were held in trust. This type of specialized trust (Grantor Retained Annuity Trust, or GRAT) is particularly attractive today because of the dual combination of today's lower stock values and lower interest rates.
Low-Interest Rate Family Loans
Suppose instead of making an outright gift of securities to his daughter, Edward, seeing great value in real estate these days, agrees to loan his daughter money to acquire a home or other real estate, at today's record low interest rates. Edward has written loan documents prepared and lends his daughter $100,000 at current market interest rates. Each year thereafter, Edward could "forgive" the principal and interest payments, up to the annual gift tax exclusion amount, that his daughter would otherwise be required to make to him under the promissory note.
Because the loan's interest rate is low, (i) Edward's daughter will "repay" this loan much faster than at a higher interest rate, (ii) Edward's taxable estate may be reduced by up to $100,000, and (iii) all of the appreciation of the real estate she acquires will be in her estate, not Edward's. If Edward had decided instead to purchase a $100,000 piece of real property with the intention of giving it to his daughter on his death, the entire appreciated value of the real property at Edward's death would be included in his taxable estate. A low interest family loan that permits the child to purchase the property would avoid this inclusion.
All of the techniques and strategies discussed in this article are time-sensitive and if desired should be investigated and undertaken soon while market prices are low and interest rates are low. When the prices of securities and real estate recover and interest rates increase, these unique opportunities will have passed.
Copyright (c) 2009 by Robert M. Phillips. All rights reserved.
Gifting as an Estate Planning Strategy
Under current tax law, assets that you transfer to others for no consideration are subject to a federal "transfer tax." If you transfer these assets during your lifetime, the transfer tax is called a "gift tax." If you transfer these assets at your death, the transfer tax is called an "estate tax." Each tax is imposed on the value of the assets transferred. Thus, the larger the value of the assets transferred, the greater the tax. Conversely, the lower the value of the assets transferred, the smaller the tax. And, if the value of the assets transferred is so low as to fall under certain thresholds, there is no transfer tax.
It is this last objective that forms the basis for all tax-reducing estate planning and that clients and estate planners seek-that is, reduce the value of the assets transferred at death and the transfer taxes will also be reduced, or possibly eliminated! By making lifetime gifts of assets, the gifted assets will not be included in the donor's estate at the donor's death and the estate tax will, by definition, be smaller (or none).
There are limits, however, both tax-wise and economically, to the value of assets that you can gift to others. To reduce the possibility, and opportunity, of taxpayers completely avoiding estate taxes at death (by giving away all, or most, of their assets during their lifetime) the tax code imposes a "gift tax" on every asset, including cash, that one gives away during one's lifetime. Under these laws, that $50 birthday check that you mailed to your nephew would be subject to the federal gift tax were it not for an "annual gift tax exclusion" that requires the IRS to ignore taxing "small" gifts.
It was not generosity on the part of the Congress or the IRS that prompted this exclusion. Rather is was mere practicality. Can you imagine the IRS trying to tax all of these kinds of small gifts? When originally instituted, this exclusion was $3,000 per donee per year. As of January 1, 2009, the exclusion has increased to $13,000 per donee per year. To qualify for the exclusion, the gift must be a gift of a "present interest" which, generally means the donee must actually receive, or have the opportunity to receive, the gift during this year.
For example, a married couple with three children could gift a total of $78,000 in assets to their children (by the husband and wife each making a $13,000 gift to each of their children) this year without any requirement to report the gift to the IRS or pay any gift taxes.
If, on the other hand, gifts to any person in a given year exceed the annual gift tax exclusion, those gifts will appear on the IRS radar because a gift tax return is now required and there may be gift tax payable. However, the tax laws allow each of us to make a total of $1 million in gifts exceeding the annual exclusion amounts during our entire lifetime, gift tax free. Once again, this is not an example of benevolence or generosity by the Congress or IRS as these tax-free lifetime gifts (in excess of the annual exclusion amounts) will reduce the value of assets, dollar-for-dollar, that are allowed by the tax code to be transferred tax free at death.
There still is an advantage to making such gifts now (as compared to the same gift made at death) in that the growth, or appreciation in value, of the asset after the gift is made during your remaining lifetime will not be included in your taxable estate at death. If you hold the asset until you die, the full appreciated value of the asset will be subject to tax. This strategy of transferring an asset today, at today's value, to your intended beneficiaries, and thus avoiding all of the appreciation of the asset being taxed to your estate at your death, is at the crux of why today's economic environment provides a good opportunity for making gifts.
Of course, all lifetime gifting is premised on the fact that the donor can and is willing to make gifts during his or her lifetime. If the assets are needed by the donor during the donor's lifetime, outright gifting may not be a viable strategy. In those situations, gifting may still appropriate but techniques other than "outright gifts" may apply. If it is practicable, making lifetime gifts that are not subject to gift tax should be a primary objective, among others, of all estate plans.
Two facts make gifting in today's economic environment a good strategy: First, as of January 1, 2009, the annual gift tax exclusion amount is larger than it has ever been, thus permitting larger tax-free gifts. And secondly, with the value of many asset classes (securities, real estate, etc.) being lower than in recent times, larger amounts of gifts of those asset classes can be transferred, tax-free, today.
Outright Gifts of Depressed Assets
Consider Edward, who owns 1000 shares of Widget, Inc.. In 2007 Widget traded at around $25 a share. Today, the market price of Widget has dropped to $13 per share. Edward could gift all 1,000 shares of Widget to his daughter today and not be required to file a gift tax return or pay any gift tax. Edward believes that eventually Widget will recover its share price and that by making the gift today he will be able to transfer more shares to his daughter and eliminate all of the expected growth in the value of the holdings from his taxable estate. This strategy will apply to gifts of all asset classes that have declined in value, or that one expects to increase in value in the future.
Custodial Gifts to a Minor
If Edward's daughter were a minor, she could not hold and manage the shares in her own name. Instead Edward would need to transfer ownership of the shares to a Uniform Transfer to Minors Act (UTMA) custodial account. Edward should not be the custodian of this account. Under current tax laws, if Edward were both the donor and custodian of the assets, the assets would be included in his taxable estate at his death! This would defeat one of the major objectives of transferring the shares to his daughter and should be avoided.
A recognized disadvantage to transferring assets to a custodial account is that upon attaining twenty-one years of age the assets must be conveyed outright to the child. To avoid this, Edward could use a trust.
Gifts of Depressed Assets in Trust
If Edward's daughter were a minor, or if for any other reason Edward wanted to transfer stock to her but wanted did not want her to have control of the shares immediately upon the gift, Edward could establish a trust and transfer the shares to the trust for her sole benefit. Edward would not be the trustee of the trust, but could control who is the trustee. The value of the shares transferred would still be determined by the value at the time of the transfer (i.e., today's depressed value) permitting more shares to be transferred. If, when and how his daughter receives income and the principal of the trust would be determined by Edward at the time the trust is created and included in the written trust agreement that established the trust.
A disadvantage to making annual exclusion gifts to a trust is that, as noted earlier, in order for these gifts to avoid being subject to gift tax, they must be gifts of a "present interest." A gift into a trust, even a trust solely for the benefit of a single beneficiary, generally does not qualify for such an exclusion. However, by making each gift to the trust subject to so-called "Crummey" powers (simply stated an unrestricted right of withdrawal by the beneficiary for a limited period of time), the gifts can qualify as gifts of a present interest and not be subject to gift taxation.
Gifts in Trust of "Needed" Assets
Suppose Edward wants to give his daughter stock, and take advantage of today's depressed prices so he can give her more shares, but Edward has been enjoying the regular dividend distribution of the stock and decides that he needs keep the income for himself. In this situation, instead of giving the shares outright to his daughter, or to a trust solely for the benefit of his daughter, Edward decides to give the shares to a trust that is designed so that for a specified term of years Edward retains and will receive all of the income of the trust. At the end of the term of years, the shares can then pass to his daughter. If the shares have appreciated in value, Edward has been successful in eventually transferring the shares to his daughter at today's market price, thus avoid transfer taxes on all of the growth in value of the shares while they were held in trust. This type of specialized trust (Grantor Retained Annuity Trust, or GRAT) is particularly attractive today because of the dual combination of today's lower stock values and lower interest rates.
Low-Interest Rate Family Loans
Suppose instead of making an outright gift of securities to his daughter, Edward, seeing great value in real estate these days, agrees to loan his daughter money to acquire a home or other real estate, at today's record low interest rates. Edward has written loan documents prepared and lends his daughter $100,000 at current market interest rates. Each year thereafter, Edward could "forgive" the principal and interest payments, up to the annual gift tax exclusion amount, that his daughter would otherwise be required to make to him under the promissory note.
Because the loan's interest rate is low, (i) Edward's daughter will "repay" this loan much faster than at a higher interest rate, (ii) Edward's taxable estate may be reduced by up to $100,000, and (iii) all of the appreciation of the real estate she acquires will be in her estate, not Edward's. If Edward had decided instead to purchase a $100,000 piece of real property with the intention of giving it to his daughter on his death, the entire appreciated value of the real property at Edward's death would be included in his taxable estate. A low interest family loan that permits the child to purchase the property would avoid this inclusion.
All of the techniques and strategies discussed in this article are time-sensitive and if desired should be investigated and undertaken soon while market prices are low and interest rates are low. When the prices of securities and real estate recover and interest rates increase, these unique opportunities will have passed.
Copyright (c) 2009 by Robert M. Phillips. All rights reserved.
Current Economic Environment
Provides Opportunities for Gifting
Provides Opportunities for Gifting