Gifts as Part of An Estate Plan

Gifts as Part of an Estate Plan

How Gifts Are Taxed

How Gifts Can Save Taxes for You

Why Gifts May Not be a Good Idea for You

INDEX TO THIS PAGE - LINKS

    How Gifts Save Taxes
    Federal Gift Tax Generally
    Spousal Gifts and Split Gifts
    Unified Credit Gifts
    Pennsylvania Taxes
    Tax Saving Techniques
    Advantages and Disadvantages of Lifetime Gifts

How Gifts Save Taxes

Making gifts can be an excellent way for a person to save taxes - both Federal Estate Tax and Pennsylvania Inheritance Tax. The basic principle involved with gifts is that if you really give something away while you are alive - it will not be in your estate when you die and therefore, your heirs will not have to pay taxes on it. If you do not really give it away - for example - if you keep the right to use the property or to receive the income from the property or if you keep the right to cancel the gift - then the property will still be taxed in your estate when you die. The more that you really give away while you are alive - the less there will be to be taxed when you die. It seems simple but there are many factors which must be considered in deciding whether lifetime gifts make sense for you. We will try to review some of those factors in this article about gifts.

Federal Gift Tax Generally

Many people have a vague notion that they can give away up to $10,000 (or $11,000 or $12,000) but don't understand why this is a "magic" number or exactly what this means. The reason for the $10,000 limit is the Federal Gift Tax. The Internal Revenue Code contains a number of taxes in addition to the Federal Income Tax and the Federal Estate Tax. One of these other taxes is the Federal Gift Tax. This tax is imposed on every gift except those subject to specific exclusions under the law. For example, charitable gifts are excluded from the tax. Gifts to your spouse are not excluded but are subject to a deduction that results in no tax on gifts between citizen-spouses.

Generally gifts to other persons are subject to this tax at the same rates as the Federal Estate Tax - today up to 46% of the value of the gift. However, there is a provision in the law that states that everyone is entitled to make gifts each year of up to a certain amount to any one person and there is no limit on the number of persons who can receive those gifts. The limit had been $10,000 each year per person. Effective for year 2002, that limit was increased to $11,000 and effective for year 206, the limit is now $12,000. In other words, you can now make as many $12,000 gifts as you wish each year without incurring any gift tax obligation as long as no single person receives more than $12,000 from you in any one calendar year (January 1 - December 31). You can pay the same person $12,000 on December 31 and another $12,000 gift-tax free on the following day - January 1 - because the gifts are in two different years. You cannot pay a person $12,000 on January 1 and then make another $12,000 tax-free gift to the same person on December 31 of the same year - even though the two gifts are almost a year apart - because both gifts are in the same calendar year. These gifts of up to $12,000 are called "Annual Exclusion Gifts."

By taking advantage of the Annual Exclusion provision in the law, the Federal Gift Tax law permits you to reduce the potential size of your estate by making $12,000 gifts each year to as many people as you wish. You can make these gifts to your children, your grandchildren, your great grandchildren, your other relatives, your friends or anyone else. Your relationship to the person is immaterial. The amount of the gift is the amount of money given away or the fair market value of any property given away, valued as of the date of the gift. This technique of making Annual Exclusion gifts can result in very substantial savings of Federal Estate Tax and Pennsylvania Inheritance Tax.

Spousal Gifts and Split Gifts

If you are married and if your spouse has his or her own property - your spouse can make his or her own $12,000 gifts and together you can double the amount of the gift to each person from $12,000 to $24,000. In addition, even if one spouse has no property of his or her own, if your spouse is willing to join in your gift (by filing a properly prepared gift tax return), you can double the amount of your own gift. This is called "gift splitting." In other words, even if all the money or property comes from you and not your spouse - you can still make $24,000 annual gifts. However, you cannot split your gift (and make a $24,000 gift to someone instead of a $12,000 gift to that person) if your spouse also made his or her own $12,000 gift to that same person. $24,000 is the maximum from both you and your spouse together to any one person.

Unified Credit Gifts

The Internal Revenue Code also permits each U.S. citizen to give away a certain amount of money or property during his or her lifetime without paying any Federal Gift Tax by using his or her "Unified Credit Amount." This amount has changed - in 2000 and 2001 it was $675,000. In 2002 it changed to $1,000,000 and that remains the current level. Under current law, it is not scheduled to increase again even thought this threshold amount for Federal Estate Tax is scheduled to increase. Every U.S. citizen can use his or her Unified Credit Amount either against Federal Estate Tax or against Federal Gift Tax. This means that when a person uses his or her Unified Credit to eliminate or reduce Federal Gift Tax, the amount that can be used later to reduce Federal Estate Tax is itself reduced. In other words, if a person makes a gift of $1,000,000 during his or her lifetime - the Unified Credit Amount can be used to eliminate the Federal Gift Tax completely. However, if that person dies in the year 2006, and if he or she still has an estate of more than another $1,000,000, a portion of estate may be subject to Federal Estate Tax. (The Unified Credit Amount for Federal Estate Tax was increased to $2,000,000 for 2006.) In 2009, the Unified Credit Amount will increase for Federal Estate Tax but not for Federal Gift Tax. Even though lifetime gifts may mean that a portion of the Unified Credit Amount will not be available to be used against the Federal Estate Tax, there may still be a good reason to make the gift during lifetime - particularly if the property to be given away is going to increase in value. A lifetime gift allows you to eliminate the tax - not only on the value of the gift - but also on all the appreciation that will take place after the date of the gift.

Pennsylvania Taxes

There is no Pennsylvania gift tax - gifts generally do not cause Pennsylvania tax problems. However, unlike the Federal tax scheme, a gift does not take the gifted property out of your taxable estate for Pennsylvania Inheritance Tax purposes unless the gift is made at least one year before the date of death (except for the first $3,000 of the gift in a calender year). Although "death bed" gifts can be effective to reduce Federal Estate Tax - they do not work for Pennsylvania tax purposes. Another reason to plan early.

Tax Saving Techniques

If your estate is going to be large enough - one object of a good estate plan is to remove as much property from your estate as fast as you can at the lowest gift tax value as possible. If your estate is not large enough - this may be a certain route to financial disaster. However, if your estate is large enough, there are many completely legal techniques for increasing the tax savings. There are also other techniques that may or may not be accepted by the IRS. This article cannot properly describe all the available techniques - either the legal ones or the ones that fall in the "gray areas". You may have heard of some of them - GRATS - GRUTS - Personal Residence Trusts - Family Limited Partnerships - Charitable Remainder Trusts - and many others, all of which are completely legal. Consultation with a knowledgeable lawyer can help you decide if any of them are appropriate for you. Another technique that can help preserve your real estate and save taxes is to make a gift of a Conservation Easement. (Conservation Easements are more fully discussed in another article at this Web Site.)

Advantages and Disadvantages of Lifetime Gifts

There are both advantages and disadvantages to making gifts as part of your estate plan. Some of the more significant considerations are listed below.

Advantages of Gifts

Avoid Federal Estate Tax on Gifted Property
Avoid Pennsylvania Inheritance Tax on Gifted Property (if you survive the gift by one year)
Avoid Estate or Inheritance Tax on Appreciation in Value After Date of Gift
Your Children or Grandchildren Can Enjoy the Gift Now
Income From the Gifted Property May be Taxed at a Lower Income Tax Rate
You May Be Entitled to a Charitable Deduction on Income Tax if the Gift is to a Qualified Charity

Disadvantages of Gifts

You Lose Control Over the Gifted Property
You Cannot Retain Income From the Property
You Cannot Demand the Return of the Property Even if You Need It
Gifted Property May be Subject to Claims of the Recipient's Creditors
Gifted Property May be Subject to Divorce Proceedings of the Recipient
Your Eligibility for Assistance From Medicaid for Nursing Home Expenses May be Affected

Summary

Lifetime gifts may be a part of a good estate plan but they are not right for everyone. They can involve a very simple plan or an extremely sophisticated plan. We suggest you consult with a knowledgeable estate planning attorney in the state where you live to help you decide if they should be part of your own estate plan.

Warning - The topics discussed in this article are covered in only a very general way. There are many detailed and sometimes complicated additional factors to be considered. This article is intended only to give the reader a broad overview. This article is for informational purposes only and does not constitute legal advice. Your particular circumstances may affect your tax obligations and the effects from gifts that you might make. You should not rely on this article in taking any action or refraining from any action without first consulting an attorney who practices law in the state where you live.

Notice Pursuant to Final Regulations Under Circular 230, effective June 20, 2005

The opinions contained in any communication on the web site are not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code.

Revised January 2006

Fromhold Jaffe & Adams
Attorneys at Law
Villanova Center - suite 220
789 East Lancaster Avenue
Villanova, Pennsylvania 19085
610-527-9100
www.fromholdjaffe.com

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