The purpose of this letter is to give you some information regarding strategies available to make the most effective use of lifetime gifts, including the annual exclusion, the exclusion for tuition and medical expenses, marital and charitable gifts, and trusts for minors.
As you are aware, gifts to family members, charities, and others are an effective way to reduce one's taxable estate. Each individual may make annual gifts to any number of recipients without paying any gift tax if the gift to each recipient does not exceed $14,000.00 per year. The annual exclusion amount was indexed for inflation beginning in 1997 and has slowly increased over the years. Where the amount will go in 2014 and beyond depends on inflation, and can only be increased in increments of $1 ,000.00.
For example, Janet has three married children and each child has two children. Each year, Janet can give gift-tax-free $14,000.00 to each of the three children, their spouses, and the six grandchildren, for a total of 12 individuals and an aggregate sum of$168,000.00. Janet's husband, John, can make similar gifts so that together the couple can give a total of $336,000.00 each year. Every year, a husband and wife can give to as many individuals as they wish up to $28,000.00 without paying any gift tax, while at the same time reducing their estates by the amount of the gift and thereby avoiding estate tax on the transferred property.
If, as in the example above, Janet and John would rather conserve their cash, but have other property they can give to their children and grandchildren, this often produces better results than cash gifts.
Janet and John own an apartment house worth $1 ,000,000.00. If they are able to transfer the property by using the annual exclusion gifts, they will have an opportunity, over time, to transfer the asset out of their estates thus eliminating the transfer tax on it completely, including any tax on the increase in the value of the property. In the case of Janet and John, having an opportunity to give an aggregate of $366,000.00 per year, as aforementioned, they can transfer the entire property over a three-year period to their family. This would save their heirs over $450,000.00, or more, in estate tax that would have been due on this property if it had been retained in Janet and John's estate until the second spouse's death.
Another important planning technique for gift giving is that in a two-day period, these gifts can be made to cover two calendar years. To qualify, the gifts need only be made in separate tax years. Accordingly, on December 31 gifts can be made for one year, while on January 1 gifts can be made for the subsequent year.
Back in the example of the apartment house worth $1,000,000.00 owned by Janet and John, each year for three years they can give to their 12 children and grandchildren fractional interests in the apartment house without giving away any cash. Because they are transferring fractional interests to their descendants, they are entitled to claim a valuation discount for such interest.
According to the Internal Revenue Service, a willing buyer will not pay the same price for a fractional interest in property as he would pay for the entire property. A fractional interest is less valuable because it is a minority interest and is difficult to market. Fractional interest discounts are recognized by the I.R.S .. The only dispute is the size of the discount. Retaining expert appraisers to value the asset is essential to establish an appropriate discount that may be accepted by the I.R.S ..
The giving period may be reduced further if Janet and John decide to make gifts in excess of the annual exclusion by using all or part of their unified credit exemption equivalent, i.e., the lifetime maximum amount which for 2013 is $5,250,000.00 per person. This means that each person may, during his lifetime or death, give away, estate tax-free, property having a value of up to $5,250,000.00. The annual exclusion gifts, previously discussed, so long as they do not exceed $14,000.00 per year per recipient, and $28,000.00 per year if given by a husband and wife, will not erode the unified credit.
If Janet and John's property is held by a limited partnership or a limited liability company, Janet and John can make gifts of limited partnership interests, or comparable LLC interests. These interests would have no managerial power and Janet and John can continue as the general partners, or comparable LLC managers, and retain the sole management responsibility. If giving away a corporate structure, Janet and John may retain control through a shareholders' agreement giving them the right to elect the board of directors of the corporation.
Making gifts is also a way to achieve what is known as income-splitting. In the case of the transfer of the apartment house, Janet and John have reduced their estates at no gift tax costs, and at the same time have transferred income to their children and grandchildren. For example, if the apartment produces $60,000.00 of taxable income each year, the children and grandchildren will receive and pay tax on their respective shares of the income.
There is also an exclusion for education and medical expenses gifts. Any gifts for these expenses, without monetary limit, may be made in addition to the $14,000.00 annual exclusion previously discussed, so long as the payment is made directly to the provider such as the college, the hospital, the doctor, the dentist, or medical insurance carrier. Educational expenses are limited to tuition alone. These gifts may be made on behalf of anyone, including unrelated persons.
A special section of the Internal Revenue Code deals with trusts set up for minors. Gifts in trusts for individuals under age 21 qualify as present interest gifts eligible for the annual exclusion if:
(1) The trust property and income may be used only for the benefit of the minor child;
(2) The trust assets pass to the minor child on attaining age 21, or his estate or designee if he dies before age 21.
The nice thing about the trust for minors is that it may contain a clause permitting the minor to extend the term of the trust beyond age 21, which makes it more desirable than transfers under the Uniform Gifts to Minors Act which contains no such options.
Then there are the charitable gifts which, of course, include outright gifts of money or other property to a charity.
However, charitable gifts may also be structured to provide additional benefits to the donor. For example, a charitable remainder trust is a trust from which the donor receives an annuity, an income stream, up to a maximum of20 years. At the expiration ofthe trust, the assets pass to the designated charity that is the remainder beneficiary. The donor of a charitable remainder trust receives an income tax and gift tax charitable deduction for the current value of the remainder interest even though the gift is not actually paid to the charity for many years in the future.
The annuity amount is a fixed annual payment based on the initial value of the property contributed to the charitable remainder trust. For example, if the initial contribution has a fair market value of $100,000.00, a 5% minimum annuity would equal $5,000.00.
The very opposite of the charitable remainder trust is the charitable lead trust. In this trust, the charity receives the trust income for a term of years, and at the end of the term, the property reverts back to the donor. The donor receives a charitable deduction for the value of the income interest given to the charity.
There are other gift giving techniques that can be explored, including the gifting of a personal residence with the donor retaining the right to live in the residence, known as a personal residence trust.
For further information, contact the law office of Ross A. Skolnick, P.C ..