Manage Your Wealth with Gift Tax Planning
When you read about gift taxes, it’s probably most often in association with estate planning. But those interested in smartly managing their wealth need a gifting strategy — both for estate planning purposes and for minimizing the taxes they and their loved ones could face in the here and now.
Looking to the future
Making lifetime gifts is particularly attractive for assets you expect will appreciate significantly in the future, 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 transfer tax and remove future appreciation from your taxable estate.
Plus, the gift tax exemption is $5 million through 2012. So, if you can afford to do so, you may want to give as much as possible up to that amount before Jan. 1, 2013. Also consider your $13,000-per-recipient annual gift tax exclusion ($26,000 if splitting gifts with your spouse).
Of course, the income tax impact must be factored into any gift tax strategy. Under current law, when your heirs inherit assets, their tax basis is generally “stepped up” to the assets’ current fair market value, minimizing or eliminating capital gains taxes in the event of a sale. But gifted assets don’t enjoy a stepped-up basis, which means that, if the assets appreciated in value while you held them and the recipient sells them, he or she may have significant income tax exposure.
Forming an entity
Transferring interests in a family business or other closely held company using a family limited partnership (FLP) or a family limited liability company (FLLC) may be a wise gifting strategy. In a typical arrangement, you form a limited partnership or LLC to own your business (or your interest in a business) and then transfer limited partnership interests or nonmanaging LLC interests to your children or other family members. By maintaining a small ownership interest and acting as general partner or managing member, you retain the right to manage the business indefinitely.
FLPs and FLLCs offer important benefits. They can provide family members with an ownership stake without giving up managerial control, and can offer some protection from creditors’ claims against limited partners or nonmanaging members. In addition, valuation discounts can allow you to minimize or even eliminate gift taxes when you transfer a minority interest in the business.
The IRS frequently challenges FLPs and FLLCs. So to avoid undesirable tax consequences and even penalties, it’s critical to structure and manage your FLP or FLLC properly.
Exploring a trust
Trusts are another gifting option to explore. When you establish certain trusts — such as grantor retained annuity trusts and charitable lead annuity trusts — your children or other beneficiaries receive a “remainder interest.”
In other words, at the end of the trust term, after the annuity payments have ceased, 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.
To calculate the remainder interest, the IRS assumes that the trust assets will grow at the Section 7520 rate in effect during the month the trust is funded. The lower that rate, the smaller the remainder interest and, therefore, the smaller the gift. If, and to the extent, the trust’s growth and earnings outperform the Sec. 7520 rate, your beneficiaries will reap the benefit of that excess growth and earnings without any additional gift tax cost to you.
By setting up and funding these types of trusts now, you may be able to lock in a low interest rate, making it possible to transfer a significant amount of wealth while minimizing gift taxes.
Forging a path
These are just a few basics to consider when devising a strategy for minimizing taxes when gifting. The nature of your wealth, as well as your goals for yourself and your loved ones, will help forge the right path for you.
Please contact Feeley & Driscoll's Boston Accounting team by Email or call us at 1 (888) 875-9770.
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