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The Ins And Outs Of Lifetime Gifting

It’s a simple truth of estate planning. Giving money to your heirs while you’re alive is almost always a better deal, in terms of taxes, than having your wealth distributed after you’re gone. Yet, according to a recent survey by Charles Schwab, though seven in 10 affluent individuals consider estate taxes a major concern, fewer than a third say they have taken advantage of lifetime giving strategies that could cut their potential estate tax liability.

The following example shows why it’s better to make gifts sooner than later. Suppose you earmark four quarters for your children. If you die and are in the highest estate tax bracket, almost 50% of your gift will go to the government. So, the kids get just two quarters. Now suppose, instead, you gave them two quarters now. You might owe gift tax, again at about a 50% rate. That costs you one quarter, not two, and your children get to keep the extra 25 cents.

Under the first scenario, your kids get 50 cents, total. Under the second, they get 50 cents in gifts plus about half of the last quarter after paying estate taxes when you die. They end up with roughly 25% more than they’d have gotten without the gifts during your lifetime.

In reality, your children would probably make out even better. That’s because the IRS lets you give as much as $13,000 annually (a couple can give $26,000) to any number of recipients without incurring any gift tax. A couple with three children, for example, could transfer $78,000 a year to the kids throughout Mom’s and Dad’s lifetimes without ever owing a penny in gift tax. Moreover, you can make unlimited tax-free gifts to your spouse as long as the spouse is a U.S. citizen. Additionally, you can provide “support” to your children or dependents without it being considered a gift. The same is true when you make payments on behalf of your children or others for tuition to educational institutions and medical providers.

All of this adds up to a considerable sum you can move out of your estate without paying taxes. And there’s more. You also get a lifetime gift-tax exemption of $1 million. Any time you exceed the $13,000 annual limit, the excess is counted against your exemption. So, for example, if you give your daughter $25,000 this year, $13,000 will be forever exempt from gift taxes, and the other $12,000 must be reported to the IRS and subtracted from your $1 million exemption. Only when the exemption is used up do you owe any gift tax.

Some wealth-transfer strategies can help you stretch your exemption even further, by discounting the value of your gifts so that a gift actually worth $15,000, might count as just $13,000 for tax purposes, and wouldn’t exceed the annual exemption amount. Valuation discounts can apply to gifts of interests in real estate, businesses, or securities, among other assets. In some cases, the gift is discounted because of a lack of liquidity or control; in others, it represents a remainder of interest paid after a period of time. These strategies may involve a qualified personal residence trust, grantor retained annuity trust or unitrust, or family limited partnership.

Keep in mind that some gift-giving strategies may involve paperwork. If you go above the $13,000 annual limit, for example, you must file a gift tax return. Couples taking advantage of the “splitting” provisions that allow them to give $26,000 a year also need to file the return, even though their gifts don’t reduce their lifetime gift exemptions.

If the estate tax is repealed on schedule in 2010 (and no one can know for sure how that will turn out) you could live to regret having paid gift taxes. But unless Congress acts to extend the repeal, which is unlikely, the estate tax comes back to life in 2011, and distributing all or part of your wealth before you die and not afterward could really help your heirs keep a larger share.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.

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