Taxes

Every person has a lifetime gift and estate tax exemption of $5.43MM (this number rises with inflation). Generally, most gifts made during a lifetime are counted towards this lifetime exemption.  If lifetime gifs exceed $5.43MM, a gift tax is due. If the sum of lifetime gifts and the money remaining in the estate exceeds $5.43MM, an estate tax is due. There are some gifts, however, that are not counted towards this exemption, and can be made without filing a gift tax return.  

Annual Exclusion:

A person is permitted to give annually up to $14,000 of assets per donee without this money being counted toward his indexed lifetime gift tax exemption.  A couple is allowed to give up to $28,000 per year per donee. For example, if you are married and you have 3 children, you and your spouse are allowed to give them 3 * 28,000 = $84,000 per year without filing a gift tax return.

A gift amount greater than $28,000 will not necessarily incur a tax liability, but it is required to be reported on a gift tax return and it will be counted toward a lifetime gift tax exemption. For example, if you gave $1MM in 2014 to your son, $986,000 will be reported on your gift tax return filed in 2014. No taxes will be due that year, but your lifetime gift tax exemption will be reduced to $4,356,000.

Whether or not you or your estate will actually owe any taxes on the gifts made over the annual exclusion will depend on your lifetime gift amounts. Currently, the lifetime gift tax exemption is $5.43 million per person. If the sum of your gifts made over the annual exclusion amount and the amount remaining in your estate at the time of death is over $5.43MM, then federal estate taxes will be due.

What can you give as a gift: The gift does not necessarily have to be in cash and does not have to equal the total value of the asset. For example, people gift fractional interest in businesses (LLCs, corporations), stocks, real estate, art work, etc. A fractional gift may be quite useful in terms of valuation because discounts for the lack of control and lack of marketability may also be applied.

Currently, there is no limit to the number of recipients. Therefore, if you have 20 children and grandchildren, you may gift up to $280,000 per year to them. However, the current proposal from the Obama administration would limit this amount to $50,000 a year. It is unclear whether this proposal would pass.

Medical and Educational Expenses

One can also give unlimited payments directly to qualified medical and education providers. Therefore, a grandfather can pay for his grandson’s college education, without having to file a gift tax return. The only stipulation is that the donor must give the money directly to a medical provider or school.

Gifts to Spouse

All gifts made to a spouse, both during the life and from your estate after the death, are federally tax free. However, the spouse must be a US citizen in order to take advantage of this law. Gifts to a spouse who is a non-US citizen are also possible, but with limited exemptions.  

Gifts to Charitable Organizations

Gifts to qualified charitable organizations are exempt from the Gift Tax.

Why would you want to make gifts during your lifetime?

1. The main reason is to reduce the size of your estate. Currently, the lifetime exemption is $5.43MM, a number which most people feel comfortable that they will never reach. However, this number may decrease (as it has in the past). Currently, the Obama administration proposes to reduce the lifetime exemption amount to $3.5MM. The number may be decreased even further. All gifts made as part of the annual exclusion amount are not counted in the estate, and will not incur the estate taxes (currently 40%).

2. Another reason to gift an asset is to shift the income to a person with a lower tax bracket. If the gift is of a property which generates income, the income tax will have to be  paid by a donee.

3. Another reason is to plan for the property that has the potential of high appreciation. If one owns stock of a closely held corporation that is currently worth $1MM but may be worth $10MM in the near future, it may be quite advantageous to transfer the stock (either to a child or to a trust) before the appreciation occurs. This way, only the $1MM of the lifetime gift exemption will be used, and no federal estate taxes will be due on the higher amount.

What are the disadvantages of making lifetime gifts?  

The main disadvantage is the lack of control. After all, you are giving up the assets. Your donees are free to sell, spend or transfer these assets, and you are not entitled to the income.  

Another disadvantage is the loss of the step up in basis. All completed gifts retain the basis of the donor. Therefore, if you gift a real estate with a basis of $100,000 that later appreciates to $1MM, the donee will retain the basis of $100,000 and may have to pay high capital gains taxes at the time of the sale.

A significant disadvantage for making lifetime gifts is Medicaid planning. If there is a potential that one may have to go into a nursing home in the next 5 years, then very careful planning must be done, because Medicaid may impose a long penalty.

This article only offers general information.  Each situation is unique. It is always helpful to talk to a specialized attorney, to figure out your various options and ramifications of actions.  As every case has subtle differences, please do not use this article for legal advice. Only a signed engagement letter will create an attorney client relationship.

Earlier I wrote a post about what is the step up that President Obama wants to eliminate. Currently, the step up in basis is the favorable tax treatment that heirs get if the assets were held until death by the parent. If the mother buys stock at $20 a share, holds on to it until the share price rose to $100, and then dies, the heirs will not need to pay any capital gains on the appreciation. Obama wants to eliminate this ‘loophole’, treat death as a taxable event, and make $80 appreciation taxable immediately at death.

The unintended consequence of this proposal would likely be an increased use of trusts. If the mother holds the stock that she bought at $20, and thinks that the stock is likely to appreciate significantly (such as, for example, shares of a closely held corporation), she would be better off transferring the stock into a trust. For example, if she transfers the stock when it is worth $30, under the new proposal only $10 would be immediately taxable. Any further appreciation (such as when the stock reaches $100) would take place inside the trust. As a result, it would be outside the estate of the mother, and the mother’s death would not trigger a taxable event.

There are multiple assets who would benefit from being transferred to a trust if this proposal goes through. Art work, income producing real estate, stock of a closely held corporation – basically all the assets that heirs might want to hold on to after the parents’ death, yet whose value is high enough that heirs might not have sufficient cash to pay the death taxes.

http://www.forbes.com/sites/janetnovack/2015/01/20/obama-attack-on-trust-fund-loophole-could-increase-tax-advantage-of-trusts/

This article only offers general information.  Each situation is unique. It is always helpful to talk to a specialized attorney, to figure out your various options and ramifications of actions.  As every case has subtle differences, please do not use this article for legal advice. Only a signed engagement letter will create an attorney client relationship.

This is an extremely valuable tool in the long term tax planning that saves middle class thousands of dollars in taxes every year. It also enables families to pass on their most valuable possessions at death without the need for beneficiaries to immediately sell it.

What is it? Under the federal tax code, if a tax payer holds an asset until his death, the owner’s cost basis for such asset rises to the full market value at the time of death. That means that the starting point for measuring a tax gain rises to the value of the asset at the time of death. This has huge tax saving implications for the people inheriting the asset.

How does it work? For example, your grandmother bought some stock 50 years ago for $50,000. Now that same stock is worth $1,000,000. If your grandmother holds the stock until her death and you inherit it, your cost basis in the stock becomes $1,000,000. If you sell the stock a week after her death, you will not have to pay any capital gains taxes.

On the other hand, if your grandmother gifts you the stock during her life time, then you will “inherit her basis,” and your cost basis of the stock remains $50,000. If you sell the stock for $1,000,000, you will need to pay capital gains taxes on $950,000. The same result is achieved if your grandmother sells the stock during her lifetime. She will have to pay capital gains taxes on $950,000.

Why the step up in basis was fair: some people think that by having a step up in basis, families are unfairly avoiding the taxes. But the estate tax catches an inheritance at the other hand. If the grandmother was holding the stock at her death, that stock was included in her estate. As a result, depending on the state in which you live in, both federal and state estate taxes may be due. New Jersey taxes estates that are greater than $675,000. New York State taxes estates that are greater than $2MM (set to rise to $3.1MM on April 1^st). The federal government taxes estates that are greater than $5.43MM.

President’s Proposal: Under the President’s proposal, the step up in basis would be eliminated. Any time an asset would be inherited or gifted, it would be treated as a sale, and taxes on capital gains would be due.

Exemptions from the President’s proposal: There are some notable exemptions from the proposal, made in order to ease the burden on middle-class Americans.

• Capital gains of up to $100,000 per individual can be bequeathed free of tax for any type of asset.
• Capital gains of up to $250,000 per individual can be bequeathed free of tax for a personal residence.
• No tax would be due on inherited small business – until such business gets sold.

Implications for estate planning: If the proposals pass the Congress, most of the existing estate plans will need to be re-evaluated and likely modified. At this point, given a Republican-controlled Congress, it is unclear whether any of these proposals will actually become law.

http://www.whitehouse.gov/the-press-office/2015/01/17/fact-sheet-simpler-fairer-tax-code-responsibly-invests-middle-class-fami