If you’re like most people, you don’t like to think about planning your estate. But it’s an important part of ensuring the financial security of your loved ones. One of the most common tools used in estate planning – and one that everyone should at least give careful consideration to – is a program of giving gifts. A carefully planned gift-giving program can reduce the amount of your estate that is subject to tax while still passing on wealth. For more information, keep reading or feel free to call one of the NYC accountants at MEDOWS CPA, PLLC.

Congress has not made estate planning easy over the past several years. There has been a general indecisiveness among legislators over the minimum amounts that should be excluded from gift and estate taxes and the tax rates that should apply to amounts not excluded. As a result, taxpayers have only temporary amounts with which to plan, making long-range strategies more difficult.

The American Taxpayer Relief Act of 2012 (ATRA), passed by Congress on January 1, 2013 and signed into law by President Obama the next day, brought some much-needed certainty to estate planning situations. The unified gift and estate tax exclusion at $5.45 million for 2016 (an increase from $5.43 million in 2015). The top gift tax rate is 40 percent.

Absent the immediate financial needs of a gift recipient, the main motivation for making large gifts during your lifetime rather than waiting to pass on your wealth at death is to remove the future appreciation from your eventual taxable estate. There is a certain degree of risk in this strategy since your donee receives a tax basis equal to what you paid for the asset while your heirs will receive a stepped-up tax basis equal to the assets value at death, As a result, the loss of stepped up basis and higher future tax rates on capital gains may diminish the benefits of current gift giving. Nevertheless, the consensus planning purposes is that getting future appreciation out of a taxable estate still trumps worries about any more remote tax issues for your donees if and when they eventually were to sell the gifted assets.

While large gifts can be subject to rules with a multitude of variable, you can give away up to an “annual exclusion amount” per recipient per year free of gift tax and free of any future offset against any exemption amount used to lower future gift or estate taxes. For 2016, that annual exclusion amount is $14,000.

There is a great deal of flexibility in the types of property that can be transferred. Gifts that qualify for the $14,000 annual exclusion can be made in money, property such as stocks or bonds, or even a life insurance policy, as long as the recipient gets the present right to possess or use the property. The gift may be in trust if the terms of the trust give the recipient the immediate right to the property or income from the property.

You can give up to $28,000 in 2016 per recipient per year if you are married and your spouse consents to “split” your gifts. This is useful for spouses who do not own an equal amount of property. The spouse with less property can consent to gifts made by the wealthier spouse, thereby effectively doubling the amount that the wealthier spouse can give away tax-free. To take advantage of “gift splitting,” both spouses must be U.S. citizens or residents. The consent must be given on a gift tax return, so a return must be filed even if no gift tax is due. However, a short form gift tax return is available. Don’t underestimate how an annual gift-giving plan using the $28,000 split gift exclusion per donee alone can facilitate the tax-efficient transfer of family wealth.

As emphasized in discussing large gifts, above, but equally applicable to smaller gifts, it is important to remember when you make a gift that the recipient must take your basis in the property. This means that if the recipient sells the property, any gain on the sale will be measured using what you paid for the property, not what the property was worth when he or she received it. In contrast, if property is transferred to another through your estate and whether or not estate tax is owed, the recipient can use the value of the property at that time in measuring any gain on the sale of the property. Consequently, choosing the right property to achieve your goals is an important aspect of any gift-giving program.

Another way to further the financial security of others without incurring gift tax is by payment of medical and educational expenses. You can pay an unlimited amount for these expenses tax-free as long as the payments are made directly to the medical services provider or educational institution. The person you benefit does not need to qualify as a dependent for tax purposes. Any medical expenses, however, must not be reimbursed by insurance, to either you or to the beneficiary.

If used properly, a program of gift-giving can benefit everyone involved. The passage of ATRA made it all the more important for you to consider how a gift giving plan can be advantageous now. If you have any questions about the best way of using gifts as part of your overall financial plan, please contact one of our Certified Public Accountants in New York.

Property Acquired by Gift or Through an Estate

Receiving a gift or a bequest or other inheritance carries with it a unique set of federal income, gift and estate tax rules that must be observed. Knowing what the rules are will help you prepare for any tax consequences that may ensue upon the ultimate sale or other disposition of the property.

The recipient of a gift or a bequest pays no gift or estate tax. Those taxes, if they are due, are payable by the donor (the person making the gift) or the estate in the case of a decedent. Generally, no gift tax is due for gifts to any one person that do not exceed $14,000 in 2016 ($28,000 in 2016 if the gift is given jointly by a husband and wife). Gift tax payable over those amounts can also be avoided by using the unified estate and gift tax lifetime exclusion of $5.45 million for 2016, as adjusted for inflation.

Under the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act), Congress revived the estate tax for decedents dying in 2010. The 2010 Tax Relief Act provides for a $5 million exemption and a maximum tax rate of 35 percent for estates of decedents dying after December 31, 2009 and before January 1, 2011. However, estates of decedents dying in 2010 can elect between (1) the estate tax with a $5 million exemption/maximum 35 percent tax rate and the stepped-up basis rules, or (2) no estate tax and the modified carryover basis rules. Any election is revocable only with the IRS’s consent.

A maximum estate tax rate of 40 percent and an applicable exclusion amount of $5.45 million ($10.9 million for married couples) is also imposed for decedents dying on or after January 1, 2016. A lower, 35 percent rate generally applied to 2009-2012 estates.

Basis. The basis of property received by gift or bequest is used by the recipient to determine whether there is gain or loss on a subsequent sale or other disposition of the property. These rules can be complex.

Gifts. If property has been acquired by gift, the basis to the donee (the recipient) for income tax purposes is the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift (carryover basis). However, the basis for loss is the lower of the carryover basis or the fair market value of the property at the time of the gift. In some cases, there is neither gain nor loss on the sale of property received by gift because the selling price is less than the basis for gain and more than the basis for loss.

In the case of a gift on which gift tax is paid, the basis of the property is increased by the amount of gift tax attributable to the net appreciation in value of the gift. The net appreciation for this purpose is the amount by which the fair market value of the gift exceeds the donor’s adjusted basis immediately before the gift.

Gifts to noncitizen spouses and foreign gifts. The first $145,000 of gifts in 2014 to a spouse who is not a U.S. citizen will not be included in taxable gifts. A U.S. person receiving aggregate foreign gifts in excess of $15,358 in 2014 must file an information return.

Bequests or through intestacy. Property received from a decedent under a will or by operation of law generally enjoys a “stepped-up” basis set at the property’s fair market value at date of death (or several months thereafter at the election of the executor). (Estates of decedent’s dying in 2010 had an election to forego the basis step-up in lieu of paying any estate tax, but that opportunity has ended.) Most recipients of property from an estate find the stepped-up basis advantageous since it lowers the potential amount of capital gain tax due upon the sale of the asset. Depending upon the age of the donor, the advantage of stepped-up basis, therefore, can figure significantly into planning whether to give gifts during a lifetime or wait to pass property through your estate.

If you have any further questions on this topic, or how the rules apply to your specific situation, please do not hesitate to contact a NYC CPA.

Estate Planning – Estate Tax Marital Deduction

Although you can leave everything you own to your spouse free of estate tax, doing so can actually increase overall estate tax costs at your spouse’s death (unless special portability rules apply). The reason for this is that each person can leave up to $5 million of assets (adjusted for inflation) to children or other non-spouse beneficiaries without any federal estate tax liability. This “exclusion amount” of $5 million, increases to $5.45 million in 2016 because of the built-in inflation adjustment. By leaving everything to your spouse, however, you will waste this exclusion amount.

As an example, say the husband has $6 million and the wife has $340,000. The husband could leave everything to the wife without owing any estate tax. However, the wife’s estate would owe tax on $1 million of the $6.34 million (ignoring any growth in value for simplicity). She could leave $5.45 million to the children (or anyone else) free of estate tax, but the husband’s $5.45 million exclusion would be lost forever. That could cost the family $400,000 (assuming a rate of 40 percent).

This tax could be avoided by leaving $5.45 million to the children and the rest to the wife. The first estate would still owe little or no tax. And the wife’s estate also would owe little or no estate tax on her remaining share.

If there is a concern that the $1 million would not be enough for the wife, it’s possible to also leave the income from the other funds to her for her life, using what is called a credit shelter trust. The husband’s estate would be able to shelter the $5.45 million that ultimately will go to the children and that amount won’t be subject to tax in the wife’s estate.

Of course, if the spouse owning few assets dies first, he or she could lose the opportunity to transfer $5.45 million to the children free of tax. This may be dealt with relatively easily by having the wealthier spouse transfer funds tax-free during life to the other spouse.

Under a special portability provision, the surviving spouse may elect to apply any unused estate tax exclusion that was not claimed by the estate of the decedent spouse.

In the example above, suppose the husband dies in 2012 with an estate of $6 million, and leaves the entire estate to the wife. The husband’s estate would not use any of the $5.12 million exclusion (the inflation adjusted amount for 2012); instead, the estate would take the marital deduction for the assets passing to the wife. The estate would file Form 706 and elect to transfer its unused exclusion to the wife. If the wife then dies in 2016, for example, the wife’s estate (equal to $6.34 million) would apply its own exclusion of $5.45 million and the husband’s unused exclusion of $5.12 million, for a total exclusion of $10.57 million. Thus, both the husband’s and the wife’s estates will be able to escape estate tax.

There also are situations in which the marital deduction can be used to save tax and at the same time address non-tax concerns. For example, there are circumstances in which leaving all the funds outright to a spouse may not be desirable. Typically, one or both spouses may be concerned about the management of the property, or may want to make sure that particular beneficiaries ultimately get the property. That last concern probably arises most often when there are children of a prior marriage.

In any of these situations, individuals often use what is technically called a QTIP trust. While various requirements must be met to qualify as a QTIP, the most important thing is that your estate can qualify for the marital deduction without your leaving the property outright to your spouse. You only need give the income from the property for the spouse’s life.

As you can see, the marital deduction is a powerful and flexible tool that can yield great benefits when properly coordinated. However, careful planning, including taking into account income tax considerations and practical considerations is necessary. Feel free to contact one of our Accountants in New York City for more information.