Giving away assets during your lifetime with the goal of reducing your taxable estate can be an important planning strategy. But with recent increases in gift and estate tax exemptions, many are feeling less pressure to make these gifts. The exemption amount is now “permanent” and set to increase with inflation instead of requiring Congress to approve increases. For 2015, that exemption amount is $5,430,000.
With this large of an exemption, many believe they will never need to consider estate taxes or planning. But consider that when it comes to estate tax law, permanence is not necessarily forever. It simply means that no expiration date has been set.
Create a Program for Gifting
A regular program of lifetime gifting can help insure against future tax law changes. A taxpayer can make annual gifts up to $14,000 ($28,000 for gifts by married couples) tax-free to any number of recipients. After that annual threshold, the donor must file a gift tax return and the excess is counted toward the $5,430,000 gift and estate tax exemption.
Example: A married couple can gift each of their children $28,000 annually. This means a couple with five children can give their children a total of $140,000 per year tax-free, without eating into their exemptions. And this amount will go up in the future as the annual exclusion is adjusted for inflation.
You can also pay tuition and most medical expenses on behalf of your children or other beneficiaries without using your annual exclusion or lifetime exemption amount. For these gifts to be nontaxable, you must make the payments directly to the school or health care provider. Reimbursing the beneficiary will not work.
Nontaxable gifts — such as annual exclusion gifts and direct payments of tuition or medical expenses — are especially effective because they reduce your exposure to estate taxes while using none of your exemption amount.
Taxable gifts — those that use up some or all of your $5,430,000 exemption — could also make sense. Consider that even if lawmakers reduce the exemption amount, it is unlikely that the lower exemption would be applied retroactively to gifts that take advantage of the current exemption.
Freezing the value
If you own assets expected to appreciate in value, giving them to your children or other loved ones — either outright or by way of an irrevocable trust — freezes their value for gift and estate tax purposes.
Income tax savings
Even if you are not concerned about gift and estate taxes, gifting can produce income tax savings. For example, by transferring income-producing assets to your children or other family members in a lower tax bracket, you can reduce your family’s overall tax burden.
Keep in mind, though, that this income-shifting strategy will not work if your children are young enough to trigger the “kiddie tax”. That kiddie tax applies your marginal rate to most of a dependent child’s unearned income. This applies to children age 18 or younger (23 or younger for full-time students).
Also, if you give away highly appreciated assets, the recipients will take over your tax basis. This can trigger substantial capital gains tax if they sell the assets. For such assets, consider whether there is a tax advantage of waiting until death to make the transfer, when your beneficiary will get a step-up in basis.
Planning Pays Off
If your wealth exceeds the $5,430,000 exemption or is likely to exceed the exemption during your lifetime, gifting continues to offer significant tax saving opportunities. Your tax advisor can help you design a lifetime gifting plan that makes sense for your unique situation.