Estate Planning Opportunities in a Down Market
July 1, 2009 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
Note: This article discusses federal tax rules only. Individual states impose their own property transfer taxes using rules that may be different from the federal rules.
Basic Gifting
Each year, you can make gifts of up to $13,000 to anyone you want, to as many people as you want, tax free under the annual gift tax exclusion. You can give away twice that amount if both you and your spouse make the gifts together (this is called gift splitting). And, you can give away an unlimited amount if you pay tuition or medical bills on behalf of another person (just be sure to make these payments directly to the school or health-care provider
Family loans
You can lend money to your children at the current IRS minimum interest rate (known as the AFR, which changes monthly), and then potentially forgive an amount equal to the gift tax exclusion each year. (The gift tax exclusion amount is adjusted for inflation; $13,000 is the figure for 2009.
Grantor retained annuity trust (GRAT)
A GRAT is an irrevocable trust with a specified term (e.g., 10 years) into which you gift assets that you expect will greatly increase in value in the future. You receive annuity payments during the trust term, and at the end, your beneficiaries receive any remaining propertyThe transfer of assets to the GRAT is a taxable gift to the trust beneficiaries. The value of the gift for tax purposes is determined based on the current IRS rate (known as the 7520 rate, which also changes monthlyTax savings are achieved because the annuity payments are calculated to result in a gift tax value of zero. It’s anticipated, however, that the actual interest earned will be higher than the 7520 rate, leaving a substantial value in the GRAT at the end of the term. This remaining value is passed on to your beneficiaries tax free.
Intentionally Defective Grantor Trust (IDGT)
An IDGT is an irrevocable trust that has a purposeful flaw (i.e., you retain some control over the trust) so that you, and not the trust entity, pays the income taxes on trust income (thus, an IDGT is ideal when you want to transfer income-producing assets). Even though you retain some control over the trust, IDGT assets will generally not be included in your taxable estate at your deathYou sell assets to the IDGT in return for an installment note, with interest calculated based on the current AFR. There is no gift tax because it is a “sale” (except for an initial gift that “seeds” the trust). However, because you and the trust entity are considered the same taxpayer, no gain is recognized on the sale, and interest you receive under the note is not considered taxable income>Tax savings are achieved because, hopefully, the value leaving your estate via the sale will exceed the value returned to your estate via the note. You also reduce your estate by paying the income taxes on IDGT income.
Charitable lead trust (CLT)
A CLT is an irrevocable trust with both charitable and noncharitable beneficiaries. It’s called a lead trust because it is the charity that is entitled to the first or lead interest from the trust property. After the specified term, the remaining trust property passes to you or another named noncharitable beneficiaryAt the time assets are placed into the CLT, you receive a current gift tax deduction equal to the present value of the income stream that will be going to the charity. The interest rate used is based on the current 7520 rate. The lower the interest rate, the higher the deduction. As with a GRAT or IDGT, it is hoped that the CLT assets will appreciate beyond the 7520 rate, allowing the excess to pass tax free.
These gifting strategies, and others, can turn this economic downturn into a mixed blessing.
Ten Gifting Traps to Avoid
November 6, 2008 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Lifetime gifting can be a powerful estate planning tool. Transferring property during your life, instead of at your death, has many advantages. Making lifetime gifts can be desirable for personal reasons (e.g., to help your children or other family members) or for financial reasons (e.g., saving taxes). No matter what your reasons for starting a gifting program, there are a few gifting traps you should be aware of.
1. The kiddie tax rules
Beware of the kiddie tax rules when transferring income-producing property to your children. Investment income over $1,800 (for 2008) will be taxed at your marginal income tax rate, not your child’s.
The kiddie tax rules apply to children who are: (1) under age 18, (2) age 18 with earned income that doesn’t exceed one-half of their support, and (3) ages 19 to 23 who are full-time students with earned income that doesn’t exceed one-half of their support.
2. Gifts of retained interests or powers
Be careful when making gifts of property in which you retain some financial interest (e.g., a life estate, right of reversion, or right of revocation) or powers (e.g., the power of appointment). This property may be includible in your estate for estate tax purposes.
For example, say you transfer ownership of your home to your son on the condition that you’re allowed to continue living in the home for the rest of your life. You have retained a financial interest in the home, and this interest may be includible in your estate for estate tax purposes.
3. Income taxation of gifts made to a trust
Some types of trusts are taxpaying entities, which are taxed at more compressed income tax rates than individual taxpayers. If you’ll be using such a trust, be sure to consider the consequences of paying income tax on trust income at higher income tax rates.
4. Delays in making a gift of life insurance
Do not delay making a gift of a life insurance policy on your life. A transfer of an insurance policy by gift within three years of death results in the proceeds being includible in your estate for estate tax purposes.
5. Delays in planning your estate to meet percentage tests
Do not delay removing certain nonbusiness assets to help your estate meet the percentage tests to qualify for Section 303 (redemption of stock), Section 2032A (special use valuation), or Section 6166 (installment payout of taxes) tax treatment. This technique will work only if the gift is made more than three years prior to your death.
6. Payments for tuition or medical care made to the donee
Payments you make for tuition or medical care on behalf of another are exempt from federal gift tax. However, to qualify, you must make the gifts directly to the educational or medical institution–do not make such payments to the donee.
7. Overlooking gift splitting
For 2008, you can give $12,000 per donee federal gift tax free under the annual gift tax exclusion. There is also a gift-splitting privilege for spouses who qualify that can double the exclusion.
8. “Reverse” gifting if death is imminent
Reverse gifting is a technique where a healthy individual transfers low-basis assets to a dying individual. If the decedent lives for more than one year from the date of the transfer, the basis gets stepped up to fair market value. However, the basis will not get stepped up if the decedent dies within a year of receiving the gift, and should this happen, you may end up needlessly paying gift tax and/or using up your $1 million gift tax applicable exclusion amount.
9. Overlooking the benefit of taxable lifetime gifts
Don’t assume that lifetime gifts and transfers made at death result in the same tax effect. Paying gift tax on taxable lifetime gifts can result in an overall tax savings because the tax you pay is also removed from your estate.
10. Selecting property that does not attain your tax-savings objectives
There are some types of property that you should avoid giving if you want to enjoy tax savings, such as property that has depreciated in value or is likely to depreciate.