Gifts to Family Members
No one wants to see the bulk of their estate go to Uncle Sam. And yet, gift and estate
taxes can deplete a significant portion of your estate if you don't adopt an effective plan
to transfer your assets to others.
One of the best ways to gradually transfer your estate tax-free is to use the annual
exclusion and "gift" up to $12,000 per person in 2007 to an unlimited number of
recipients. If you and your spouse choose to "split" gifts, then $24,000 per person, per
year, can be given away tax free in 2007. Gift-splitting isn't necessary in community
If you'd like to make a gift to a grandchild (or anyone else), and wish to exceed the
annual exclusion amount, then you should make a direct payment to the providers for
education (tuition only) and medical expenses. Gifts of this nature do not count toward
the annual limit.
In certain circumstances, you can also exclude gifts of pre-paid tuition.
EGTRRA makes it more important than ever to coordinate gifting with your overall
estate plan. The biggest change is the creation of a differential between the estate tax and
gift tax unified credit, and the continuation of the gift tax after repeal of the estate tax.
Avoid making gifts of highly appreciated property that likely won't be sold before your
death. Left in your estate, it would get an automatic step-up in basis to fair market value.
This could save your heirs significant income tax when the property is eventually sold.
If you have stock that's temporarily depressed in value but has high appreciation
potential, consider giving it to your children now. The gift tax impact (which is
determined by fair market value on the date of the gift) will be reduced. When the
stock price recovers, you will enjoy a second benefit: the increase in value won't
increase your estate tax base.
One of the best ways to gradually transfer your estate is to use the annual exclusion and
"gift" up to $12,000 per person to an unlimited number of recipients. If you and your
spouse choose to split gifts, then $24,000 per recipient can be given away tax-free. Gifts
may be made directly to the donee or in trust for the donee's benefit. Many estates can be
completely transferred to others—free from tax—in this way over time.
There are special requirements when a trust beneficiary doesn't have a present interest
(i.e., does not enjoy current benefits from the trust property). Gifts to such trusts don't
qualify for the annual exclusions, so they are fully taxed. In the case of trusts set up for a
minor, annual exclusion gifts are allowed, but the minor must have full access to the trust
assets at age 21.
One possible solution to the "present interest" problem is to create a "Crummey" trust for
greater flexibility and control. This requires that you give each trust beneficiary a right of
withdrawal when funds are transferred to the trust. Transfers to the trust which are
subject to "Crummey" powers will qualify for the annual exclusions.
Or, consider creating a family limited partnership (FLP) or limited liability company
(LLC), to which you can transfer property (such as rental property) and then gift interests
to family members without relinquishing full control. The fact that the IRS may allow a
substantial valuation discount when the gifts are made makes this approach very
The GST Tax
Attention grandparents! Transfers to your grandchildren are also subject to the
generation-skipping transfer (GST) tax, which is imposed at a flat 45% for 2007. The
GST tax goes away in 2010... but will be resurrected in 2011 unless Congress acts first.
Each spouse has a lifetime GST exemption of $2.0 million in 2007 available to shelter
transfers from the GST tax. This amount corresponds to the estate tax exemption amount
and increases over time, until repeal in 2010. To see how the reform affects exemption
amounts, click here.
Post-gift appreciation escapes the estate tax.
To the extent of the $12,000/$24,000 per donee, per year annual exclusion, no
transfer tax is ever imposed.
Gift tax paid reduces your taxable estate. (Limited exceptions apply.)
Post-gift income produced is taxed to lower tax bracket donees.
The $12,000/$24,000 gift tax annual exclusion can still be available to you for
transfers to minors even though their current access to the trust property and its
income is severely restricted.
Gift and Estate Taxes
Every estate may exclude a certain amount of property from estate taxes. In 2007 that
amount is $2.0 million. Furthermore, you may give away up to $1 million during your
lifetime tax free, but doing so will reduce the amount you are able to transfer tax free at
death. This gift tax exemption applies to gifts that do not qualify for the annual exclusion.
The amount you can transfer tax free at death will increase to $3.5 million in 2009. In
2010, both the estate tax and generation skipping transfer tax are repealed. However, the
gift tax exemption equivalent is permanently capped at $1 million. (See table below.)
For both you and your spouse to take full advantage of your own estate tax exemptions,
you each must own property that has a value equal to the exemption for the year of death.
To ensure this result, consider making tax-free gifts to your spouse (they qualify for the
unlimited marital deduction). Special planning applies to states with community property
Prior to 2010, lifetime gifts in excess of annual exclusion amounts will be aggregated
with and use up a portion of your estate tax exemption. However, because the gift tax
exemption is smaller than the estate tax exemption, you could end up with a taxable gift
even if no estate tax is due at death.
If you wish to make gifts of more than
$1 million, consider transferring assets to heirs in exchange for an installment note.
The note can be forgiven (or distributed to the heirs) at death and be sheltered by
the additional estate tax exemption (or be free from estate tax if repeal occurs).
However, the transfer will be subject to income tax, so we need to compare the costs
and benefits of this strategy.
Estate, GST, and Gift Tax Exemptions
Estate/GST Tax Exemption
2007 & 2008 $2,000,000 $1,000,000
2009 $3,500,000 $1,000,000
2010 Estate/GST Tax Repealed $1,000,000
2011 & after $1,000,000 $1,000,000