Lifetime Gifts Are an Effective Estate Planning Strategy

It’s an odd year for estate planning. As of this writing, the 2010 estate and generation-skipping transfer (GST) tax repeal still stands. And both taxes are scheduled to return in 2011 — at their pre–tax-cut top rate of 55% and with exemptions significantly smaller than in 2009. Meanwhile, Congress might take action — or it might not. Although this has given rise to much estate planning uncertainty, making lifetime gifts is still an effective strategy.

Why Lifetime Gifts are good

Making lifetime gifts is particularly attractive for assets you expect will appreciate significantly, such as stock, real estate or interests in a closely held business. By transferring these assets to family members while values are low, you can minimize or eliminate gift tax and remove future appreciation from your taxable estate.

In 2010 the gift tax is still in effect, but you can make the most of your $13,000-per-recipient annual gift tax exclusions ($26,000 if splitting gifts with your spouse) and $1 million lifetime gift tax exemption. It might even make sense to make gifts in excess of these amounts while the gift tax is at the low 2010 rate of 35%. But beware that Congress could increase the rate retroactively to Jan. 1 or take other action that would make such gifts costly.

An uncertain step

Be sure to consider income taxes as well as gift and estate taxes. Recipients of gifted assets don’t enjoy a “stepped-up” tax basis, which means your basis (generally, what you paid for the assets) carries over to the recipient. When heirs inherit assets, however, their basis is generally stepped up to the assets’ current fair market value, minimizing or eliminating capital gains taxes when the assets are sold. So it’s typically beneficial from an income tax perspective to bequeath, rather than gift, highly appreciated assets.

But 2010 is a little different. During the estate tax repeal, the stepped-up basis is limited. (Ask your financial advisor for details.) Additionally, a 0% long-term capital gains rate applies to taxpayers whose ordinary income would be taxed at 10% or 15% — but, as of this writing, it’s available only through 2010. So gifting appreciated assets to loved ones eligible for the 0% rate may make sense if they’ll sell the assets by year end.

If you’re considering gifting assets whose value is less than your basis, it may make sense to sell them instead so you can deduct the loss. Then you can gift the cash you receive from the sale.

The benefit of trusts

Some of the most effective gifting strategies involve trusts, and many, such as a grantor retained annuity trust (GRAT) or charitable lead annuity trust (CLAT), are more powerful when interest rates are relatively low. When you establish a GRAT or a CLAT, your children or other beneficiaries receive a “remainder interest.” In other words, at the end of the trust term, whatever is left in the trust is distributed to your beneficiaries. When you fund the trust, you make a taxable gift equal to the present value of this remainder interest.

The Section 7520 rate (an IRS assumed rate of return) in effect during the month the trust is funded is used to calculate the remainder interest. The lower that rate, the smaller the remainder interest and, therefore, the smaller the gift. If, and to the extent, the trust outperforms the Sec. 7520 rate, your beneficiaries will reap the benefit without any additional gift tax cost to you.

A fine time

Just because, technically, there may be no estate tax in 2010 doesn’t mean you should ignore estate planning. In fact, during this time of uncertainty, you may want to check up on your estate plan more often to make sure you’re not missing a change that could hurt — or help — you. And if you’re in a giving mood, now is still a fine time to set up a gifting arrangement for your family.

If you have any questions, please contact Feeley & Driscoll's Boston Accounting team, Email us or call 1 (888) 875-9770.

related links