Lifetime Gifts: An Effective Strategy for Estate Tax Planning

May 2019 | Article

Gifting is a great way to help family and friends during life, but lifetime gifts can also be an important and effective strategy for estate tax planning.

The 2017 Tax Cuts and Jobs Act (the “Act”) increased the federal gift and estate tax exemption from $5 million to $10 million indexed for inflation. The federal exemption is $11.4 million per person in 2019. The increase in the federal exemption does not mean that planning should be postponed or put on the back burner. The increased exemption is scheduled to sunset on January 1, 2026. In 2026, the exemption will revert to $5 million per person, indexed for inflation. With the implementation of the Act, planning is more important now than it has ever been.

There are many ways to use lifetime gifts as a strategy to minimize or eliminate potential gift and estate tax liability. The first and easiest way is to take advantage of annual exclusion gifts.

Annual Exclusion Gifts
In 2019, each person may gift up to $15,000 per donee each year free of tax and without using any of his or her gift or estate tax exemptions. An example of an annual exclusion gift would be writing a check directly to the donee/recipient. It is also important to note that a married couple can consent to split gifts and transfer a total of $30,000 per donee each year, or each spouse could individually gift $15,000 to the same donee.

There are also instances in which gifts made under certain circumstances would not use an individual’s annual exclusion. An example would be a check made payable directly to an educational institution for tuition. Another example would be a check made payable directly to a provider for medical care. Therefore, an individual could pay $60,000 in tuition for the benefit of the donee and still gift the $15,000 annual exclusion to the same donee in the same year.

The use of annual exclusion gifts is a simple way to reduce the size of an estate over time and avoid using part of an individual’s federal gift and estate tax exemption.

Please note that there are circumstances in which a gift tax return may need to be filed even with annual exclusion gifts, although generally, no gift tax may be due.

Charitable Gifts
Another way that gifting can be used to reduce or eliminate estate tax is through charitable gifts. The use of charitable gifts is not only an effective way to minimize estate tax, but gifting to a charity may have income tax benefits as well.

Gifts to charities are generally deductible from the donor’s income, and the assets gifted will not be included in the donor’s taxable estate. When a donor makes an outright gift of his or her entire interest in the property, the full value of the transferred property may be offset by the gift tax charitable deduction.

For individuals who have reached the age of 70 and a half and have begun receiving their Required Minimum Distributions (“RMD”) from a retirement plan, gifting the RMD to a charity may be a way to transfer income that could potentially accumulate in their estate. For eligible tax years, individuals age 70 and a half or older can exclude up to $100,000 from gross income for donations they pay directly from the IRA to a qualified charity. Married individuals filing a joint return may exclude up to $100,000 donated from each spouse’s own IRA ($200,000 total). Gifting RMDs directly to charity is an effective strategy for individuals or married couples who may not be able to take advantage of the itemized deduction on their personal income tax return and do not need the RMDs to cover expenses; otherwise, those accumulating RMDs could increase their taxable estate and result in a potential estate tax issue.

Regardless of age, an individual can create a donor-advised fund (DAF) through a financial institution or a local community foundation and gift the desired charitable contributions over several years. The contribution is deductible at the fair market value up to the donor’s applicable percentage limitation.

Another option is for the donor to combine two or three years’ worth of contributions into a single year. This scenario would make the standard deduction an appealing option in the years in which no actual charitable gift is made. The term for this strategy is known as “bunching.” Individuals who would otherwise use the standard deduction can, to a limited degree, bunch certain deductions (e.g.: charitable deductions) into one year and give up the standard deduction for that year. The standard deduction for married couples has been increased to $24,000 and to $12,000 for individuals.

When making a charitable gift, it is also important to consider what asset or assets will be used to satisfy the gift. Appreciated assets are traditionally the preferred choice for charitable gifting for two reasons. The first reason is that the donor can deduct the full value of the gift without being taxed on the gain, and the second reason is because charities are not generally taxed on recognized gains when the contributed asset is later sold. Therefore, it may be a more tax effective strategy for the donor to gift the actual asset to the charity rather than selling the asset and gifting the proceeds.

Charitable gifting is not a strategy for everyone. However, for those who are charitably inclined, there are many ways to achieve your estate planning goals and also reduce your potential estate tax liability through charitable gifting.

Although gifting can be an effective means to transfer property during life, it is imperative to review the estate plan holistically to determine if gifting is an appropriate strategy, as there may be instances in which retaining the property until death may be more tax efficient. One consideration in retaining property is the carryover basis rule. The general rule is that the donee takes the gifted property at the same income tax basis as the property had in the hands of the donor. If the donee were to then sell the gifted asset, the donee would pay capital gains on any appreciation. The carryover basis rule is an important planning consideration because if the donor, instead of gifting the property, retains the property until his or her death, the asset would then get a step up in cost basis to the fair market value of the asset on the date of death. Common examples include low basis stock or farmland.

Conclusion
Gifting can be an effective strategy for estate tax planning. However, certain techniques and strategies may work for some individuals or couples, but not others. Careful consideration should be made as to whether gifting is the right strategy given the current conditions. Everyone has different life, retirement and legacy goals, and gifting as an estate tax planning strategy should be analyzed separately for each individual or couple based upon their unique set of circumstances. 

Please consult with a member of our Wealth Planning Team to learn more about how lifetime gifts may help achieve your estate planning goals.

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