Gifts are an important tool in estate planning. Annual exclusion gifts are one of the most frequently used means of transferring wealth to the next generations. There are a number of possible tools for making annual exclusion gifts to minors:
- gifting outright,
- gifting to a trust with Crummey powers,
- gifting to a Section 2503(c) Trust,
- gifting to a UGMA/UTMA account, or
- gifting to a Section 529 plan.
Which facts are important in selecting the type of annual exclusion gift?
The most appropriate tool(s) for your annual exclusion gifts to minors will depend on factors such as your age and health, the total amount of your estate and the specific assets you own, your tax basis in the assets, the age and personal characteristics of your intended recipients, your goals for the gifts, your and your recipients’ tax brackets. Your state’s tax laws, UGMA/UTMA statute, and Section 529 plan options may also be important considerations.
What is the maximum amount of annual exclusion gift for 2012?
For 2012, an individual can transfer $13,000 to an unlimited number of recipients (including minors) as annual exclusion gifts. A married couple can agree to have gifts treated as split gifts thereby giving as much as $26,000 to a single recipient. The annual amount is indexed for inflation, but only in increments of $1,000. That is why the annual amount has not changed in several years even though it is indexed.
Such annual exclusion gifts to minors and others are exempt from gift tax, and are not included within the giver’s estate for estate tax purposes. A significant amount of wealth can be transferred by a systematic annual gifting program without estate, gift, or generation-skipping transfer taxation. Recipients could include children, grandchildren, great-grandchildren, nieces, nephews, unrelated friends or even strangers. There is no limit on the number of recipients. The donor can give property directly, and can also arrange for gifting by his or her agent under a power of attorney if the power of attorney specifically authorizes such annual gifting.
What assets qualify for annual exclusion gifts?
Gifts might consist of cash, stocks or bonds, works of art or even real estate. For real estate valued at more than $13,000, fractional interests can be given in order to keep each year’s gift below the annual tax-free gifting limit.
The gift cannot be a “future interest in property”; this restriction makes gifts to trusts subject to special rules. Gifts to corporations also have special rules.
How do I select which assets to give away as part of my annual gifting plan?
Your estate planner can help you identify which specific assets you might use for annual exclusion gifting. Assets that are expected to appreciate in the future are good candidates for gifting in most cases since the appreciation of the asset after the gift will be outside the donor’s estate for estate taxation purposes. Depending on the relative income tax brackets of the donor and donee, assets which produce significant income might also be an appropriate gift. Assets that are subject to valuation discounts (for lack of marketability and lack of control) can be attractive alternatives, but gifting of such assets requires careful planning and documentation. The donor’s tax basis in the asset is also an important consideration, since the recipient of a gift receives the donor’s basis, while there will likely be a “stepped up” basis if the donor owns the asset at death.
UGMA/UTMA accounts are simple to open, but result in the minor receiving the assets when he or she reaches age 18 or 21 (depending on state law). The assets may also be included in the donor’s estate for estate tax purposes if the donor is custodian and dies before the minor reaches the state’s applicable age.
Section 2503(c) Trusts
A Section 2503(c) trust must meet certain requirements in order to qualify for the annual exclusion. The trust can have only one beneficiary and must be irrevocable. The trust can extend past the beneficiary’s 21st birthday only if the trust authorizes the beneficiary to require distribution of trust assets by written notice to the trustee for a period of time after the beneficiary reaches age 21. The identity of the trustee is important because selecting a parent of the child or the grantor or grantor’s spouse as trustee can result in adverse tax consequences. If the child dies before age 21, the property in the trust will generally be payable to the beneficiary’s estate.
Section 529 Plans
Section 529 plans vary from state to state. Gifts to a Section 529 plan must be gifts of cash, not property. The 529 plan account’s income is tax-free until withdrawal, and withdrawals for qualified higher education expenses are tax free. Since section 529 does not require the donor or recipient to reside in the state that sponsors the plan, it is possible to shop for the best plan. There may be state income tax advantages to investing in your state’s plan, however.
Trusts with Crummey Powers
Gifting to a trust with Crummey powers is another alterative for annual exclusion gifts to minors. “Crummey” powers are named after a federal court decision from the Ninth Circuit in 1968, found at 397 F.2d 82. However, Crummey trusts are considerably more complex than the other alternatives for annual exclusion gifting and there is significant risk that the IRS will continue to challenge Crummey trusts in the future. This adds to the attraction of other planning alternatives for many families.
Hindson & Melton LLC can assist with development of an appropriate plan for your annual exclusion gifts to minors, gifts to family members, or gifts to others.
Karen S. Hindson ©Hindson & Melton LLC September 10, 2012