Think twice before making that giftArticle added by Julius Giarmarco on March 10, 2014
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The disadvantages of making gifts discussed here are amplified if the donor does not have a taxable estate. In other words, for non-taxable estates, making gifts of appreciable property could result in a loss of stepped-up basis with no offsetting estate tax savings.
For persons with taxable estates (more than $5.34 million if single; $10.68 million if married for 2014), making gifts to reduce estate
taxes is usually a great idea. After all, the 40 percent federal estate tax is only vulnerable to lifetime gifting strategies. Gifts using the donor’s $14,000 annual gift tax exclusion ($28,000 for married couples) and/or the $5.34 million gift tax exemption ($10.68 million for married couples) not only remove the gifted property from the donor’s estate, but also the appreciation thereon and income therefrom.
Other advantages to making lifetime gifts include:
For donors with taxable estates, it may even make sense to pay gift taxes. If the donor lives three years, any gift taxes paid are removed from the gross estate. For example, gifting $1 million to an heir costs $1.4 million total, but bequeathing $1 million to an heir costs $1,666,700 total. This is particularly true for older donors with at least a three-year life expectancy.
But gifts can be disadvantageous from an overall tax cost perspective. The advantage of making a taxable gift is that the appreciation on
and income from the gifted asset is removed from the donor’s estate; but the disadvantage is the loss of a stepped-up basis. For example, if a donor uses his/her gift tax exemption to gift a $1 million asset (with a zero basis) that does not appreciate, there is no estate tax savings. However, if the donee sells the gifted asset (as opposed to holding the asset until death), the donee will only net $800,000 after paying a 20 percent federal capital gains tax. The net result could be even less if the donee is subject to the 3.8 percent net investment income tax and/or lives in a state with a state income tax.
- Obtaining fractional interest discounts by utilizing family limited partnerships, family LLCs, non-voting stock, and fractional interests in real estate.
- Paying income taxes (to further “burn” the donor’s gross estate) on gifts made to intentionally defective grantor trusts.
- Leveraging the donor’s GST exemption (e.g., by making gifts to irrevocable life insurance trusts).
- Removing assets from the donor’s gross estate for state death tax purposes.
- Allowing the donor to see the donee enjoy the gifted assets.
One way to hedge against a loss of stepped-up basis is to make the gift to an intentionally defective grantor trust. If the gifted asset does not appreciate, the donor can purchase the asset from the trust to bring it back into his/her estate (where it will receive a stepped-up basis). Another way is for the donee to hold the asset until death, where it will receive a stepped-up basis; or the donee could use a CRT to avoid paying tax all up front and possibly enjoy lower rates by spreading the taxable payments over many years. Or, if the gifted asset is real estate, a Section 1031 like-kind exchange is a possibility.
Another disadvantage of making a taxable gift could occur if the gifted asset declines in value after the gift is made. This resulting
wasted exemption would have to be compared to the step-down in basis avoided.
Finally, the disadvantages of making gifts discussed here are amplified if the donor does not have a taxable estate. In other words, for
non-taxable estates, making gifts of appreciable property could result in a loss of stepped-up basis with no offsetting estate tax savings.
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