Preserving and Transferring Wealth: Lifetime Gifts

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Chapter 7
Lifetime Gifts
The Limits on Giving

How Much May I Give Away Without a Gift Tax Liability?

Preserving and Transferring Wealth focuses on protecting the value of your assets.

To get an overview of estate planning, see our Estate Planning Guide for tips on wills, recordkeeping, probate and more.

One method of reducing your estate is through lifetime gifts. You can give $10,000 a year in cash or value of property to any number of different people without incurring a gift tax liability. (Note: Gifts of certain partial interests in property and gifts to trusts may not qualify for this exclusion.) You and your spouse as a married couple (if both are U.S. residents) can jointly give $20,000 per year to each recipient. This is true even if one spouse owns all of the gift property. You can also pay unlimited amounts of medical expenses and certain educational expenses (tuition only) and not be subject to any gift tax liability, as long as those payments are made directly to providers rather than to the donees. The $10,000 annual exclusion will be adjusted periodically for inflation.

The Taxpayer Relief Act of 1997 added a provision that allows taxpayers to spread a gift to a qualified state tuition program (QSTP) over five years. Thus, a taxpayer who contributes $50,000 in 1999 to a QSTP for the taxpayer’s child can apply his or her $10,000 annual exclusion amounts for 1999, 2000, 2001, 2002, and 2003 to the 1999 gift. Any other gifts during the five-year period to the same beneficiary will be subject to gift tax.

You can transfer sizable amounts of wealth tax free if you formulate and implement a gifting program early. You can retain effective control of the sums transferred by making gifts either to uniform gifts or transfers to minors’ accounts or to trusts managed by independent trustees who follow the written directions of the trust’s creator. If you want to retain investment, administrative, or dispositive powers, you must exercise extreme care in drafting the trust instrument to prevent the gift from being pulled back into your estate at your death.

A program of gifting must be reviewed carefully because of other economic and tax considerations. For example, the Omnibus Budget Reconciliation Act of 1993 subjects trusts and estates to the top income tax bracket of 39.6 percent for taxable income in excess of certain amounts ($8,450 in 1999).

Once the $10,000 per donee per year is exceeded, any excess may create a gift tax liability. Initially, no tax will actually be due because of the $1,000,000 lifetime exemption amount. However, once you have fully used the exemption, you will be required to pay tax.

What Are the Advantages of Gifting?

The two primary advantages of gifting are

Any postgift appreciation is not subject to the transfer tax unless the gift is included in the estate. For example, if you give property worth $10 and at death the property is worth $50, $40 escapes transfer taxes. (However, $40 in potential capital gain could have been avoided by having the asset included in the estate.)
Any gift taxes paid on gifts made more than three years before death will not be subject to estate tax. For example: A donor in the 50-percent transfer tax bracket has $1.50, which allows him or her to make a gift of $1.00 and pay tax of $0.50. If the $1.50 is retained in the estate, the heirs will receive only 50 percent of the $1.50 or $0.75, as compared with the $1.00 gift. Thus, heirs may benefit by early transfer even when the maximum transfer tax is extracted.

Consider a typical situation in which a husband and wife have three children, each of whom is married and has two children. A gift of $20,000 per year ($10,000 from the husband, $10,000 from the wife; or all from the husband or wife, if gift splitting is elected) may be given to each child, grandchild, and son- or daughter-in-law. Each year $240,000 (12 x $20,000) could be removed from the parents’ combined estates and would grow by any after-tax earnings or appreciation. Also, the children and grandchildren may have lower income tax rates than the parents.

Caution: Certain transfers in trust and any lifetime transfers of any interest in your business require extremely careful planning. See Chapter 6.

It is important for you to understand the effect of lifetime gifts on the computation of the estate tax due at death. As mentioned earlier, if you make gifts in excess of the allowable exclusions and deductions, you will generally have made an adjusted taxable gift that will be added back to your taxable estate. The computation of the gift tax and its effect on the estate tax are illustrated in Appendix B.

Are There Disadvantages to Gifting?

There are two main disadvantages of making gifts:

The donor loses the enjoyment and control of the property forever.
The donee’s basis for determining gain will be equal to the donor’s cost increased by the gift tax paid on the net appreciation in value of the gift, but not to more than its fair market value. The donee’s basis for determining loss will be the lesser of the donor’s basis or the fair market value of the property at the date of gift.

Also, for taxable gifts the transfer tax may be paid early.

Assume that you give property worth $30, which cost you $10, and pay a gift tax of $3. The donee’s basis will be $12, determined as follows:

Donor’s basis	$10
Gift tax on appreciation element ($3 x 20/30)	______2
Donee’s basis	$12

Is It More Beneficial to Receive Property by Gift or by Inheritance?

Property that passes through an estate generally has a basis equal to the value used in computing the taxable estate, which is usually the fair market value of the property at the date of death. In general, if appreciated property is going to be sold by the donee, it may be better to inherit the property than to receive it as a gift, since a higher basis will reduce the taxable gain.

Are Gift Taxes Payable on Gifts to a Spouse?

No, as long as the spouse is a U.S. citizen. As discussed in Chapter 2, there is an unlimited marital deduction for purposes of the unified gift and estate tax. Property may be transferred freely between U.S. citizen spouses. This provision presents a planning opportunity by allowing spouses to equalize their potential estates through lifetime gifts without incurring federal gift taxes.

If your spouse is not a U.S. citizen, you may give him or her only $101,000 per year without incurring gift tax. This amount will be adjusted periodically for inflation.

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Disclaimer: This guide is not intended to be a substitute for specific individual tax, legal, or investment planning advice, as certain of the described considerations will not be the same for every taxpayer or investor. Accordingly, where specific advice is necessary or appropriate, consultation with a competent professional adviser is strongly recommended.