Estate Planning for Financial Planners

1. Estate Planningfor Financial Planners Chapter 5: Gift Tax

2. Historical Background • The gift tax is an excise tax on the right to transfer assets to another person during life. • Developed in 1932 (after the estate tax – 1915). • Gift rates were lower. • In 1976, Congress unified the rates. • In 2003, the systems were again split.

3. EGTRRA 2001 • Tax Rate Schedules – Exhibit 5.1, page 116. In 2014, 40% • Exemption Amounts – Exhibit 5.2, page 117. In 2014, $5,340,000, large increase from previous exemption of $1 million.

4. Parties to a Gift • Donor (person who makes a gift) • Must be competent to make the gift. • Must have intent to make a voluntary transfer. • Donee (person who receives a gift) • Must be competent to receive the gift. • Must take delivery. • Must accept the property.

5. Definition of Gifts • Voluntary • Transfer of Property • Without full consideration

6. Consideration • Transfer of property or payment in return for property. • If there was fair consideration, then it is not a gift. • Bad deal: buying Tribune Company?

7. Direct Gifts • A direct payment of cash or transfer of property from one person to another.

8. Indirect Gifts • Indirect transfer on behalf of a donor for the benefit of a donee. • Makes a payment for someone else. • Titles property jointly. • Below-market loans. • The amount the lender imputes is a gift.

9. Below-Market Loan

10. Below-Market Loan Example AFR = 5%

11. Complete vs. Incomplete Gifts • Incomplete are gifts that have not come to fruition. • They are not taxable gifts for gift tax purposes. • Joint bank accounts? • Completed gifts are gifts that have come to fruition. • The donor has released all control over the asset and the donee can be identified.

12. Reversionary Interests • Interests that have been transferred by a transferor and subsequently revert back to the transferor.

13. Net Gifts • Normally the donor is responsible for all gift tax. • A net gift is a gift made on the condition that the donee pay any gift tax due. • The donor will have taxable income to the extent that any gift tax paid by the donee exceeds the the donor’s adjusted basis in the property.

14. Valuation of a Gift • FMV at the date of the gift. • Real estate – need appraisal. • Publicly traded securities are valued at the high and low trading price for the day. • Bonds – PV of the expected future payments. • Discounts may be allowed for lack of marketability, lack of liquidity, or lack of control.

15. Annual Exclusion • All individuals may gift up to $14,000 (for 2014) tax free per donee each year (adjusted for inflation). • Gift must be a present interest. • Use it or lose it! • Non-U.S. citizen spouses • “Super Annual Exclusion” = $145,000 in 2014

16. Split Gifts • Married spouses can elect to split gifts effectively doubling the annual exclusion to $28,000 (for 2014). • Requires gift tax return (Form 709). • Must be elected for all gifts for that year. • Only counts for the time they were married. • No gift-splitting for community property (no returns needed).

17. Applicable Exclusion Amount • Each person also has one lifetime credit equivalency amount up to $5,340,000 of cumulative taxable transfers. • See Gift and Estate Tax Credit chart in text for past credit amounts. • Exhibit 5.4, page 129.

18. Gifts of a Present Interest • Unrestricted right to the immediate use of the property.

19. Future Interest Gift • Interest that is limited in some way to a future date or time. • Donee’s right to the property is contingent upon some future date or time. • Example • Remainder beneficiary of a trust

20. Crummey Provision (1 of 3) • Allows the trust beneficiary to withdraw some or all of any contribution to a trust for a limited period to create a present interest. • 5/5 Lapse Rule • Taxable gift occurs when the power to withdraw in excess of $5,000 or 5% of the trust assets is lapsed by the powerholder. • Only comes into play when >1 beneficiary

21. Qualified Transfers • A qualified transfer is a payment for someone else paid directly to a: • Qualified educational institution for tuition. • Medical care provider for qualifying medical expenses. • Key here is that it must be paid directly to the institution. • Does not count against the annual exclusion or applicable exclusion amounts.

22. Payments for Support • Payments for legal support are not gifts. • Legal support does not necessarily stop at age 18.

23. Payments to Divorcing Spouses • Payments pursuant to divorce decree are nontaxable property settlements and not gifts.

24. Transfers in a Business Setting • Transfers in a business setting are presumed to be compensation, not a gift. • De minimis gifts are exceptions.

25. Gifts to Spouses • Unlimited marital deduction allows for unlimited transfers between married people without gift tax. • Spouse must be a U.S. citizen. • Different rules for non-U.S. citizens – will be discussed later.

26. Charitable Gifts • Unlimited gift tax deduction for gifts to qualified charities. • Will be covered later in Chapter 9.

27. Form 709 • Must be filed – April 15 of the following year. • Can be extended by extending income tax return. • The donor is primarily liable for gift tax but the donee can become responsible if the donor does not pay.

28. Who Must File • Everyone who gifts unless gifts are: • Under the annual exclusion. • Qualified transfers. • Transfers to spouses (generally) . • Transfers to charities. • Remember – if split gifts there must be a tax return even if less than annual exclusion (does not apply to community property).

29. Income Tax Issues Related to Gifts(1 of 2) • In general the donee will take the adjusted basis and holding period of the donor. • Exception – Asset is in a loss position • Dual basis and holding period • AB for gains – carry over holding period • FMV for losses – holding period starts at date of gift

30. Income Tax Issues Related to Gifts(2 of 2) • Exception – Gift tax paid on appreciated property • If gift tax is paid, then the basis will increase by the gift tax paid attributable to the appreciation. • Cost: $100,000 • FMV: $300,000 • Gift Tax: $90,000 • Basis: $160,000

31. Gifting Strategies (1 of 4) • Achieving client goals with direct gifts • Effective and efficient • Gifts of appreciating property • Reduces future gross estate • Gifts to spouses • Often used to equalize the estates • Gifts to minors • May need trusts or custodial accounts

32. Gifting Strategies (2 of 4) • Single party strategies • Rarely wise to gift cash. • The donor should prepare a current balance sheet with a forecast of what is likely to appreciate the most. • Transfer the asset likely to appreciate the most. • This will remove highly appreciating assets from the donor’s gross estate and the appreciation will occur in the hands of the donee. • Unless the donor is very close to death, such a strategy should generally be superior to receiving a step up in basis for transfers at death. • See Example 5.37, page 149.

33. Gifting Strategies (3 of 4) • Multi-party strategies • Never gift property in a loss position…sell it instead. • Gift property with the greatest appreciation potential to the youngest donee. • Gift appreciated property to charities to avoid the capital gain taxes. • Gift income-producing property to the donee in the lowest marginal income tax bracket so that the income is subject to the lowest possible income tax. • See Example 5.38, page 150.

34. Gifting Strategies (4 of 4) • Optimize qualified educational transfers. • Optimize annual gift exclusion. • Utilize the marital deduction to equalize estates. • Utilize the lifetime applicable gift tax credit equivalency amount ($5,340,000 in 2014). • Any gift tax paid on gifts prior to three years of death will also reduce the estate of the transferor.