Nontax motivations are, or should be, the main impetus to make gifts.
These can include:
1. Providing donees with the resources to use, to learn from, or simply to enjoy; this provides psychic gratification to the donor as well.
2. Making plans for the orderly transfer of control in a family business.
3. Setting aside a fund for a minor to grow and ultimately to provide for the minor’s education. (Gifts to minors and educational funds will be discussed in a future issue.)
4. Reducing an elderly donor’s resources to the extent necessary to allow the donor access to public assistance, e.g., Medicaid to finance a stay in a nursing facility while preserving assets for the donor’s family. (The merits and many drawbacks of this route are also reserved for a future issue.)
Nevertheless, tax consequences bear consideration. Donors may be advised to consider making gifts for the purpose of reducing future transfer taxes (gift, estate and generation-skipping transfer taxes). Gifts of income-producing property can spread the income tax around.
For many, the transfer tax avoidance factors may seem unnecessary. After all, in 2012, a married couple can potentially make overall gifts totaling $10,240,000 without incurring gift tax. That figure represents this year’s edition of the lifetime exemption from gift and estate taxes–$5,120,000 per donor! How many of us will exceed this threshold?
However, if Congress takes no action, the overall exemption is scheduled to revert to $1 million per donor on January 1, 2013. While you may feel that this is sufficient insulation from the impact of transfer taxes, be reminded that the federal estate tax covers a large swath of items that do not make a person feel particularly wealthy. A client may well wonder why he should worry about an estate tax when he cannot afford to take a vacation. But the fact that the estate for tax purposes may include the value of, say, a home that he may have purchased for a small sum years ago, plus the proceeds of insurance on his life, plus the balance in his retirement plan at work means that he gets to the $1 million threshold pretty quickly without a dime of disposable income.
Annual Gifts. The most useful tax reduction strategy is to make annual transfers that are free of the gift tax and do not erode one’s overall exemption. These are so-called “annual exclusion” gifts of up to $13,000 per donee for 2012 or $26,000 for a donor couple, even if all of the gift comes from only one of them. The exclusion rises to $14,000 for 2013. Gifts within the exclusion do not enter into the computation of the estate tax upon death.
Accordingly, a couple can make a gift of up to $26,000 for the benefit of a child or grandchild at the end of 2012 and a $28,00 gift on January 1, 2013, get a rapid $54,000 reduction in their estates, pay no tax, and leave their exemptions intact.
Education and Medical Expense: Perhaps more significantly, certain gifts simply do not count in the calculation of the gift tax—they affect neither the overall exemption nor the annual exclusion, yet remarkably few persons seem aware of them. These are the payment of tuition (not room and board or books and computers) to educational institutions and the payment of another’s medical expenses. For example, a grandparent could pay the tuition for a grandchild at a private school or college and still make a tax-free $13,000 gift to the grandchild. Similarly, a grandparent could pay for a grandchild’s orthodontia or health insurance without any tax impact at all. Note: these expenses must be paid directly by the donor to the educational institution or the healthcare provider—payments to the donee or the donee’s parent will not be exempt, even if used for the same purposes.
Income Tax. This is the factor that is most often overlooked by doting donors who want to transfer wealth to another generation. When an asset such as a share of stock is sold, there is a capital gain or a loss on the difference between the amount paid for the asset and the amount received at sale. The amount paid for the asset is the asset’s “basis.” The basis of an asset that is the subject of a gift carries over to the donee, meaning that the share of Coca Cola that you acquired years ago and give to a grandchild has the same basis that you had. This means that a substantial capital gain potential is preserved. If instead you retain the stock until your death, and bequeath it to the grandchild, the stock receives an artificial “step-up” in basis to its value at the date of death, thereby negating the gain on appreciation since you acquired it.
This potential income tax impact will affect all donors and the objects of their bounty even if they are outside the ambit of the estate and gift tax system.
Sadly, the wellsprings of generosity may require a careful consideration of tax consequences.
Also available at The Roanoke Star Sentinel