The Strategist
4th Quarter 1994 - Volume 1 Issue 1
Annual Exclusion Gifts
Gifting is an essential part of any
effective estate plan or wealth transfer plan. Section 2503 (b) of the Internal
Revenue Code allows a donor to gift up to $10,000 in value to any person during
a calendar year without having to pay a federal gift tax. The gift must be a
gift other than a gift of future interest.
A parent may gift up to $10,000 to each of
his or her children without incurring any federal gift tax. This is known as
the annual exclusion amount. Gifts of the annual exclusion amount are not brought
back into the estate if they are made within 3 years of death under most
circumstances. Parents can join together and gift $20,000 per year per child
without incurring any federal gift tax.
If you plan on making annual exclusion gifts
this year and have not yet done so, you should consider making such gifts
immediately.
Gift Early
Annual exclusion gifts should be made as
early in the calendar year as possible. There are several reasons for this but
the most important reason is that once a gift is completed, the gift is outside
of the estate of the donor.
Dad has 4 children and 6 grandchildren. If
Dad makes annual gifts of $10,000 to each of his children and grandchildren
(total $100,000) in January of a calendar year and dies in February of the same
year, Dad's estate has been reduced by $100,000. This can save up to $55,000 in
estate taxes in a 55% estate tax bracket. If Dad plans to wait until December
to make his annual gifts and he dies anytime before he makes the gifts, his
estate would pay an estate tax of up to 55% or $55,000 on the proposed $100,000
in planned, but not executed gifts.
A second consideration for making the gift
early in the year is that all appreciation in the value of the gift accrues to
the donee (the person receiving the gift).
Assume Dad gives $10,000 of stock to his
same 10 children and grandchildren in January of a calendar year and Dad dies
in December of the same calendar year. The $100,000 in gifts would be outside
of his estate. If the stock Dad gave to his children and grandchildren had
increased in value by 50% ($15,000 per share), Dad would have effectively
removed $150,000 from his estate directly to his intended beneficiaries and
saved the 55% estate tax of $82,500 on the $150,000 of total value.
Parents should also consider making annual
exclusion gifts to their children's spouses. In the previous example, Dad has 4
children and 6 grandchildren. If each of his four children were married, Dad
could increase the annual exclusion gifts from 10 gifts of $10,000 each to 14
gifts of $10,000 each if he included the spouses of his children.
If Dad is married, his wife may join in
these gifts and together they can give $20,000 per donee. This would increase
the total amount of annual exclusion gifts to 28 or $280,000 (4 children, 4
in-laws, and 6 grandchildren = 14 x 2 donors = 28 x $10,000 = $280,000).
Unified Credit
Do my annual exclusion gifts count
against the $600,000 that I can leave tax free to my heirs?
In a word, No. Annual exclusion gifts
are not allocated to this amount. Every individual is allowed to pass, by gift
or by will, up to $600,000 without incurring a federal gift or estate tax.
Married couples have a total of $1,200,000. This is called the Unified Credit
amount.
An individual can chose to use all or part
of their unified credit amount during lifetime if they so desire. Gifts of a
future interest do not qualify for the annual exclusion and generally require a
gift tax to be paid. An individual can elect to allocate their unified credit
against the gift of future interest to avoid paying a current gift tax. Any
unused amount of the unified credit is not lost at death but is carried forward
with the remaining amount used at death.
Just like annual exclusion gifts, any
appreciation of a unified credit gift made during lifetime accrues to the
recipient. The growth of the asset is not brought back into the estate of the
donor. Assume Dad gifts $600,000 of stock (his unified credit) to a child in
1994. The stock appreciates in value 8% per year. If Dad dies in the year 2004
(10 years from date of gift), the stock given to the child is now worth
$1,295,000. The appreciation is in the child's name and not Dad's estate. Dad
saves the estate tax on the appreciation.
In essence, the government has given you,
the donor, an interest free, tax free loan until death. At death, the
government cancels the loan with no adverse tax consequences.
Generation Skipping Tax
Isn't there another tax I have to pay
called a Generation Skipping Transfer Tax (GSTT) on a gift to a grandchild?
A gift that qualifies as an annual exclusion
gift that is made directly to or for the sole benefit of a grandchild will not
necessarily require a generation skipping tax to be paid. This is an extremely
delicate and tricky area of the tax law and we urge all of our clients to
contact their appropriate counsel or accountant for specific advice on this
item.
If the gift is to a trust that benefits more
than one grandchild, a Generation Skipping Transfer Tax (GSTT) will be due over
and above any gift tax. The GSTT is a flat 55% tax. Each individual has up to a
$1,000,000 exclusion from this tax that can be used during lifetime or at
death.
Basis of Gifts
A person that receives a gift assumes the
donor's cost or basis in the gift. If Dad gives his child $10,000 in stock
which Dad bought for $1,000, the child assumes Dad's $1,000 basis in the stock.
If the child later sold the stock for $50,000, his basis for calculating
capital gains tax is $1,000. If Dad willed the stock to his child, the child
would receive a step-up in basis equal to the date of death valuation.
Non-Taxable Transfers
There are additional ways Dad and Mom can
remove assets from their estates without incurring a gift tax although they are
technically making a gift.
There is an unlimited exclusion from gift
tax for certain amounts paid by one individual for another individual's medical
expenses or school tuition. In other words, Mom and Dad could pay the tuition
for all of their grandchildren. This would not be considered a taxable gift
under most circumstances. Additionally, Mom and Dad could pay the medical
expenses of their children and/or grandchildren. They cannot, however, pay for
medical insurance without it being considered a gift.
Leveraging Gifts
Once a gift has been made outside the
donor's estate, an effective technique to leverage the gift is to buy life
insurance on the life or lives of the parent(s).
Assume Mom and Dad are each 61 years old and
are in reasonable health with 3 children. If Mom makes annual exclusion gifts
each year ($10,000 per child) to each of her 3 children, the children would
receive a total of $30,000. The children could use the $30,000 they receive for
premiums to purchase a $2,000,000 last-to-die life insurance policy on their parents.
At the last death of Mom and Dad, the
children will receive the entire $2,000,000 life insurance proceeds estate tax
and income tax free.
If the parent's taxable estate is $4,000,000
and subject to a 50% estate tax ($2,000,000), the children pay the $2,000,000
estate tax from the life insurance proceeds and receive their parent's entire
$4,000,000 estate.
The
Wealth Transfer Group, Inc. is not engaged in the practice of law or accounting
nor are any of its employees, representatives, or agents. Tax and legal advice
should be obtained from qualified personnel.
(c) 1994 The Wealth Transfer Group, Inc.
283 Cranes Roost Boulevard, Suite 145, Altamonte Springs, Florida, 32701 (407)
339-5787
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