When most people think of completing estate planning documents such as a will or trust agreement, they think of how they would pass their assets to their loved ones. And indeed that is the reason we create these documents, to make sure our loved ones are cared-for once we pass.
But one of the best estate planning tools (to be used together with your estate planning documents) is to gift your assets to your loved ones while you are still alive. Lifetime giving has a number of benefits, both financially and otherwise.
Who doesn’t want to see the looks on the faces of those they care about most when their loved ones receive help with their student loans or with the down payment for their first home? Of course, your family members would be grateful for receiving this same gift after your passing, but being able to revel in your family’s happiness is part of the reason we accumulate assets in the first place. Spreading the feelings of security and freedom that go with having some extra money is as fulfilling as any reason to share these gifts with your loved ones while you are able to witness their smiles first hand. Likewise, the beneficiaries of your gifts will get to share the experience with you.
As an attorney, I do my best to keep costs under control for my clients. This ensures that the client feels he or she has received value for my services while I am able to maintain an efficient client relationship. Nonetheless, lawyer fees are lawyer fees, and if I am working to transfer property with the help of a probate judge, that is going to cost your beneficiaries money. If you transfer that car, those stock shares, or that cash while you are alive, you’re going to save some attorney fees because it is easier to transfer property while you are still alive. People often want to avoid the probate process specifically because it can be expensive.
This applies more to large estates than small or medium estates, but paying federal gift taxes on a transfer of property is cheaper than paying estate taxes for the exact same transfer after death. This is true even though the exclusion amounts and tax rates for these two taxes are identical. This is because gift taxes are exclusive, while estate taxes are inclusive. When I transfer money or assets by making a lifetime gift and owe federal gift taxes, those taxes are going to be paid by me, and will then be out of my estate . . . that tax money I just paid is now out of my estate for good, and will itself not be taxed . . . it will be excluded.
If I make these gifts at death via my will or other estate planning vehicle, that tax is assessed on my gross estate. That means the money I will have to use to pay my estate taxes will itself also be taxed: it’s included. Lifetime gifts will therefore be subject to fewer federal estate taxes than those made at death because the money used to pay the estate taxes is also itself subject to taxation. I’ll emphasize that this benefit does not apply to most Americans . . . the current federal and estate tax exemption, as of this writing, is $5,340,000 per person, which means its $10,680,000 for a married couple. That’s some big gifts that you’ll have to make before you owe any federal gift or estate taxes.
When you hold on to an asset that appreciates in value, eventually you may have to deal with estate taxes which will be assessed on the value of that asset at your death. If you have an asset that you believe will appreciate significantly over your lifetime, consider making a lifetime gift to a beneficiary or to a trust for a beneficiary. For example, if you started a small business and you owned closely-held shares of that business, you may consider giving some of these shares to your children today (taking into account possible gift tax issues). That way, as the business appreciates in value, those shares will also appreciate out of your estate.
PROCEED WITH CAUTION
There are a couple tax rules that will apply to most people. First, gifts of appreciated property made after-death get a huge tax break in the form of a step-up in cost basis. If I were to buy a share of stock for one dollar (which means the stock has a cost basis of one dollar) and it increases in value to $100 and I sell it, I would owe capital gains taxes on $99 (the sale price minus the cost basis of one dollar). This is because the sale of the stock realized a capital gain of $99. If I buy that same share of stock for one dollar, then it increases to $100 and I give it to my family member, they will keep my same cost basis. Because of this, if my family member subsequently sold it they would again realize that same $99 capital gain, and would owe capital gains taxes. If, however, I gave that same share of stock to that same family member after my death, that capital gain would “reset” . . . the new cost basis would be the value of the stock on the day I died.
That means if I buy a share of stock for one dollar, it appreciates and is valued at $100 when I die, the family member who gets that share of stock now has a cost basis of $100. If he or she sells it for $100, it is completely free of capital gains taxes. This step-up in basis is a valuable estate planning tool, and is ideal for property that has appreciated significantly. Note that this would not apply to assets that do experience capital gains, such as cash. Note also that qualified charities can receive shares of appreciation stock (or other assets) and sell these assets for cash and pay no taxes whatsoever. This is because qualified charities are tax exempt, which includes capital gains taxes. Assets that have appreciated in value are usually best given to charities or to your heirs at your passing.
ANNUAL GIFT TAX EXCLUSION AMOUNT
Another thing to watch out for is the annual gift tax exclusion amount, which is as of this writing $14,000. This means you can give up to $14,000 per year, per person. You could give $14,000 to each of your children, another $14,000 to any of your friends, etcetera. If you exceed this amount to any single person, you will typically have to file a gift tax return (Form 709) with the IRS. This is because any amount you gift to any one person over $14,000 gets subtracted to your lifetime exemption ($5,340,000, as mentioned above). The IRS wants to track how much of your lifetime exemption you have used. You may not owe tax, but you’re still going to have to file the form
Making lifetime gifts is a satisfying and generally straight forward method of estate planning. It helps your family today while possibly saving on taxes. But beware of pitfall — there are rules about how much you can give without running afoul of some complex gift and estate tax rules. Lifetime gifts are to be used in conjunction with — and not instead of — a comprehensive estate plan. A qualified estate planning attorney can guide you through these rules. I’m here to help.
Philip J. Ruce creates wills and trusts for families who want to feel secure that their loved ones are cared-for. Philip is a trust and estate attorney based in Minneapolis, Minnesota. Philip is the author of Trustee University: The Guidebook to Best Practices for Family Trustees. available at Amazon.com in paperback or Kindle edition (free chapter available here!) He also works with trustees and beneficiaries who need help with their trusts. You can contact him here.