Many financially secure individuals choose to share the wealth during their lifetime through estate planning gifts. These gifts can have the advantage of reducing estate taxes while permitting the donor to enjoy seeing the benefits of their gifts during their lifetime.
Rules about estate planning annual exclusion gifts.
The most common type of estate planning gifts are the so-called “annual exclusion” gifts which are excluded from gift tax. The current amount of annual exclusion gifting is a maximum of $13,000 per year to each individual recipient. The gifts may be made to an unlimited number of individuals. If the spouse of the donor consents, the couple can effectively give each individual recipient $26,000 per year. Since 1999, the amount of annual exclusion gifting is adjusted annually for inflation.
Many families make annual exclusion estate planning gifts each year to children and/or grandchildren in order to reduce the size of the donor’s estate. Such gifting can be used to transfer assets from one family member with a higher tax bracket or net worth to a recipient with a lower tax bracket or net worth. If the gift is invested rather than spent, the future appreciation of the gifted asset is outside of the donor’s estate for estate tax purposes. Over time, annual exclusion gifts have the potential to transfer considerable wealth estate tax-free to the next generations.
Practical considerations before making annual exclusion gifts.
There are several practical considerations in gifting to family members.
- It can be distasteful or even a source of conflict if the recipients of estate planning annual exclusion gifts become accustomed to receiving annual gifts and come to “expect” them rather than being appreciative. To avoid this possibility, it might be worth exploring other gifting alternatives such as making periodic, but not annual, gifts; or paying educational expenses or medical services directly to the service provider in lieu of giving money to the family member. Direct payments to educational institutions or medical providers for education or medical expenses are not treated as gifts under section 2503(e) of the Internal Revenue Code.
- A gift to a son-in-law or daughter-in-law stays with the son-in-law or daughter-in-law in the event of divorce.
- Making regular gifts to each grandchild will often result in an unequal distribution of your estate if your ultimate goal is to divide your estate equally between your children. This can be particularly thorny between siblings if the gifts are being made by an attorney-in-fact under a power of attorney after you become incapacitated. Decide in advance whether you want your attorney-in-fact to have the power to make gifts of your assets if you become incapacitated due to age or illness.
- Occasionally, family members will pressure a donor to make gifts he or she cannot afford. This can be very awkward, especially if the donor is dependent on the family member for assistance with daily needs such as transportation.
Estate planning annual exclusion gifts are a powerful tool in appropriate circumstances. However, you should think carefully about such gifts, your goals for the gifting, and the character and personality of the potential recipients. If you elect to make gifts to some but not all family members, animosity or jealousy may result. It is a good idea to carefully discuss your gifting ideas with an experienced independent third party such as your financial advisor or estate planning attorney. Also, you should plan in advance for your potential future incapacity, and make good decisions about whom you name as your attorney-in-fact for financial matters. Family members are not always a good choice; an independent fiduciary may be indicated if your family members are not mature and trustworthy.
Gifts in excess of the annual exclusion are a good idea in some cases.
If you have an estate that is likely to be subject to estate taxes, gifts in excess of the annual exclusion amount may be in order. For example, a gift of an asset likely to appreciate can remove the appreciation from the amount subject to federal transfer tax upon the donor’s death. Additionally, any income generated by the asset after the gift goes to the recipient, not the donor.
The $5 million current gift exemption for 2012 offers some temporary opportunities for legacy gifting within families that wish to transfer signficant wealth between generations. However, there is a possibility that using the full $5 million exemption now may subject your estate to a “clawback” of the tax to the extent that $5 million exceeds the exemption available at the time of your death. It is imperative that you avail yourself of excellent legal and financial advice if your family has significant wealth to transfer.
Good planning is important whether you have a lot, or not!
Gifting to family members is more than a financial decision. Good planning should take into account not only the tax-efficiency of the strategy, but also the family and relationship consequences of the strategy. The likely impact of the gifts on the lives of the recipients should also be considered. Hindson & Melton LLC is available to assist you in your consideration of these issues whether you have an estate worth millions or a modest nest-egg.
© Karen S. Hindson Hindson & Melton LLC August 1, 2012
