Estate planning is the process of arranging one’s affairs so that the transfer of assets at the time of incapacity, illness or death is accomplished in a most efficient manner. In achieving this efficiency, one has to try to control both tax and non-tax factors. Non-tax factors consist of unnecessary expenses such as guardianship proceedings and probate proceedings. Tax factors consist of matters such as federal gift tax issues and federal estate tax issues. The easiest approach to estate planning is to sit down with a qualified professional for an initial interview and discuss matters pertaining to your objectives and your assets.
A typical estate plan for most clients will consist of the following:
• “Pour Over” type Will
• Revocable Living Trust
• Power of attorney Health Care
• Power of Attorney for Property.
Depending on the circumstances, there are many other types of documents that may be required, such as insurance trusts, gift trusts, etc.
Gifts are subject, however, to our Gift and Estate Tax rules, which obligates the grantor (that is the person giving the gift) to pay tax on all gifts made. To begin with, you should also think that all gifts are taxable. There are a few exceptions, but if you don’t fit within one of the exceptions, then prepare to be generous to the IRS.
The Exceptions to Gift Tax
Every person has the right to gift up to $13,000, per person, per year. These annual exclusion gifts do not have to be reported to the IRS. The “per person, per year” requirement means that a single person can make multiple gifts to different people each year. So a grandfather could gift up to $13,000 to each of his children, and each of his grandchildren and not have to report the gifts, provided that no one person received more than $13,000 in a given year. Many people remember the annual exclusion gifts as being the annual $10,000 gifts. That is the prior gift tax exclusion amount before they were indexed for inflation. The annual gift amount is now $13,000.
Spouses can gift each other an unlimited amount of gifts and pay no gift tax whatsoever. The only requirement is that the couple must be legally married. Sounds simple, but it can be tricky at times.
Gift Tax Exclusion
Under our current Estate and Gift Tax laws, every individual is allowed an exclusion from gift and estate tax equal to $5,000,000. This means that you can give up to $5,000,000 away and not have to pay a gift tax on that transfer.
However, any amount of exclusion you use during your lifetime by making gifts reduces what you have left for your estate. So if you gift $2,000,000 during your lifetime, you pay no gift tax, but your Estate Tax exclusion is reduced from $5,000,000 to $3,000,000 to account for the $2,000,000 of exclusion you used while alive. Gifts in any single year to a single person that exceed $13,000 must be reported to the IRS using a Gift Tax Return (Form 709) even though no tax will be due on the return. This reporting requirement allows the IRS to track gifts made over your lifetime to determine when, and if, you exceed you tax-free limit.
As you would expect, gifts made to charity, in any amount, are free of gift tax. Luckily the IRS is not so callous as to require a generous donor to pay tax on gifts to charity. But beware, the charity must be recognized as a valid charity by the IRS under Internal Revenue Code Section. Always ask to see proof of a charity’s determination letter before making any large gifts to charity, and then confirm the charity’s status with the IRS because sometimes charitable status can be revoked by the IRS.
Tax Law Changes
When you give assets to someone whether cash, stocks or a car the government may want to know about it and may even want to collect some taxes. Fortunately, a large portion of your gifts or estate is excluded from taxation, and there are numerous ways to give assets tax free, including these:
• Using the annual gift tax exclusion
• Using the lifetime gift and estate tax exemption
• Making direct payments to medical and educational providers on behalf of a loved one
In general, it’s better to give assets to your loved ones while you’re still alive rather than after you pass away. Giving today allows your loved ones to benefit from your gifts right away and gives you the enjoyment of seeing your gifts improve their lives. In addition, those gifts can grow in value in their hands, rather than yours, which helps reduce your taxable estate. Currently, you can give any number of people up to $15,000 each in a single year without incurring a taxable gift ($30,000 for spouses “splitting” gifts). The recipient typically owes no taxes and doesn’t have to report the gift unless it comes from a foreign source. However, if your gift exceeds $15,000 to any person during the year, you have to report it on a gift tax return (IRS Form 709). Spouses splitting gifts must always file Form 709, even when no taxable gift is incurred. Once you give more than the annual gift tax exclusion, you begin to eat into your lifetime gift and estate tax exemption.
With the passage of the Tax Cuts and Jobs Act (TCJA), the gift and estate tax exemption has increased significantly. The IRS refers to this as a unified credit. Each donor (the person making the gift) has a separate lifetime exemption that can be used before any out-of-pocket gift tax is due. In addition, a couple can combine their exemptions to get a total exemption of $23.4 million. There’s one big caveat to be aware of the $11.7 million exception is temporary and only applies to tax years up to 2025. Unless Congress makes these changes permanent, after 2025 the exemption will revert back to the $5.49 million exemption (adjusted for inflation). So here is the big question if this new exemption disappears after 2025, how do you take advantage of it before then?
How To Lock In The New Exemption
For the majority of people, the gift and estate tax exemption will allow for the tax-free transfer of wealth from one generation to the next. For those who have acquired enough wealth to surpass the gift and estate tax exemption, there are several strategies that could lock in the $11.7 million exemption. The simplest way is to gift your assets to your loved ones now, rather than waiting until you pass away. If you have the means, giving the assets now has two advantages. First, you get to see your loved ones benefit from your gifts. Second, the gifted assets could increase in value for your loved ones and could decrease your taxable estate.
For example, if you were able to give the entire $11.7 million to your children today, that money could grow over time. At a growth rate of 5% per year for 10 years, that $11.7 million gift could end up being worth over $19.05 million, and your loved ones will have received the entire amount free from gift or estate taxes.
On the other hand, if you held onto those assets and you passed away in 10 years, a large portion of the $19.05 million would be taxed at 40%. Additionally, in 10 years the gift and estate tax exemption will have likely reverted back to the lower $5.49 million amount (for dates after 2025). That could result in your estate having to pay over $4.74 million in federal taxes, leaving your heirs with about $14.33 million in assets rather than $19.05 million if you made the gift sooner.
One concern many people have when it comes to giving assets away early is that sometimes the person receiving the gift may not be ready to handle the responsibility of managing such a large amount of money. A good example of this is a large amount of money gifted to a young child or teenager. One way to give those assets, but ensure they are protected from misuse, would be to give them to an irrevocable trust and make the child or teenager the beneficiary. This method allows you to set the rules of the trust and determine how the assets will be invested and distributed. For instance, you could create a trust that stipulates the beneficiary can only have access to the income generated by the assets or you could set specific rules, such as the beneficiary must graduate from college before having access to the funds in the trust. There are numerous options when it comes to structuring a trust, and each state has its own rules. If you’re interested in learning more about the various options available, take the time to meet with an attorney or tax professional in your area.
You can also make unlimited payments directly to medical providers or educational institutions on behalf of others for qualified expenses without incurring a taxable gift or affecting your $15,000 gift exclusion. This method is a great way to help out a loved one with large medical bills from an illness or to help pay for a family member’s education.
For example, say you wanted to pay your granddaughter’s $50,000 tuition for her medical degree. You could pay the university directly for her tuition and still give her an additional $15,000 tax-free. This strategy reduces your taxable estate and helps preserve your lifetime exemption.
One thing to remember about the assets you gift is that your cost basis will transfer over to the recipient. So, if that asset has appreciated in value significantly prior to the gift, the recipient could incur the substantial taxable gain when selling that asset. Highly appreciated assets that are received as part of an estate, on the other hand, generally get a “step up” in basis, which means a taxable gain could be avoided if the asset is sold soon after being received. In a nutshell, you need to carefully select what assets you gift to minimize the impact of taxes. In general, cash and assets with little appreciation are better for gifts while highly appreciated assets are better to transfer as part of your estate.
Take the time to meet with a tax and estate planning professional to ensure your gift and estate plans are well thought out and properly implemented. As with any tax planning strategy, there is always the possibility that Congress could change the laws related to the gift and estate tax exemption. You’ll want to review your gift and estate strategy each year to be sure that your plans are still relevant based on your financial situation or changes in tax laws.
The federal government imposes a substantial tax on gifts of money or property that exceed certain levels. Without such a tax, someone with a sizable estate could give away a large portion of his or her property before death and escape death taxes altogether. For this reason, the gift tax acts more or less as a backstop to the estate tax. And yet, few people actually pay a gift tax during their lifetime. A gift program can substantially reduce overall transfer taxes; however, it requires good planning and a commitment to proceed with the gifts.
Advantages of Gift Giving
You may have many reasons for making gifts for some gift giving has personal motives, for others, tax planning is what motivated them. Most often, you will want your gift-giving program to accomplish both personal and tax motives. A few reasons for considering a gift-giving plan include:
• Assisting someone in immediate financial need
• Providing financial security for the recipient
• Giving the recipient experience in handling money
• Seeing the recipient enjoy the property
• Taking advantage of annual exclusion allowance
• Paying gift tax now to reduce overall taxes later
• Giving tax advantaged gifts to minors
A qualified terminable interest property trust, or “QTIP” trust, is a specific type of marital trust designed for one spouse to provide for the care of the surviving spouse after their death. Importantly, QTIP trusts help the executor of your estate avoid state and federal taxation upon your death. QTIP trusts are generally set up to provide income to a surviving spouse upon the death of the first spouse. Because the first spouse’s assets were transferred to the QTIP trust prior to their death, the executor of the estate of the deceased spouse may elect to claim the marital deduction for the amount of money transferred to the estate or may choose not to claim the deduction. This means that QTIP trusts provide a flexible way for the executor of an individual’s estate to minimize the possibility of that individual owing an estate tax upon their death. As such, QTIP trusts, and marital trusts in general, are important estate planning tools. As can be seen, estate law is often complicated due to the changing nature of both federal and state tax laws. Additionally, proper estate planning is essential in order to make sure your estate is disposed of according to your wishes, as well as ensuring that your estate does not owe estate taxes upon your death. There are numerous estate planning tools that can ensure that your estate is not subject to federal or state taxation. Therefore, it is important to consult with a well qualified and knowledgeable estate attorney in order to protect your assets upon your death. An experienced estate planning attorney can advise you on how to avoid estate taxes by establishing a trust or making gifts throughout your lifetime. Additionally, they can draft the necessary documents on your behalf.
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It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506