Author: Steven Kriz
Clients often ask: when is the best time to make a taxable gift? One simple answer: In a presidential election year when the future of gift and estate tax exemptions is unknown, the best time to make a gift is any time before December 31 in that election year, with a preference towards an earlier time frame. The longer answer, however, is much more complex. Timing, in essence, is an art.
The determination of when to make taxable gifts is deeply dependent on the client’s assets and whether the client will be making a gift using their gift tax annual exclusion or their lifetime gift tax exemption. By way of background, the annual exclusion allows a person to gift $15,000 per person (the amount is adjusted yearly) to an unlimited number of people. Over and above the annual exclusion gifting, the lifetime annual gift tax exemption allows a person to gift up to $11,580,000 (current amount as of 2020; again this figure is adjusted yearly) gift tax free during their lifetime (this is also an exemption from estate tax).
Typically, we recommend that clients use a combination of their gift tax annual exclusion and lifetime gift tax exemption to maximize the amount of assets that they gift, removing the gifted assets and all appreciation on those assets from their taxable estate. Otherwise, those assets and the corresponding appreciation would all be subject to estate tax on death.
Adding to the time sensitivity, we are currently in the midst of an election year in which one candidate’s platform includes lowering the estate and gift tax lifetime exemption. Even if the lifetime exemption drops significantly, any gifting done should be “grandfathered,” not causing any gift or estate tax in the future. As a result, since there is a possibility that the exemption will drop, we strongly recommend that clients consider gifting this year – using all their available gift tax exemption amount, or at a minimum as much of the exemption as they are comfortable with.
Another factor playing a role in determining the timing of gifting is the type of assets the client is considering gifting. Gifting when asset values are relatively low is ideal, particularly when the subject assets are sure to mushroom in value in the future. For example, if a client owns closely-held stock and is considering a liquidation event in the future, we would typically recommend that the client make the gift as far in advance of the liquidation event as possible, on the theory that upon the liquidation event, the assets would be valued much higher. In that case, when the client makes the gift, they not only make a gift of the assets at their present value, but have also removed the future appreciation from their estate.
Consider the following hypothetical: Karen owns 100% of the stock in AB Corp. AB Corp. is currently valued at $30M. Karen is expecting that AB Corp. will be sold in the next year or so, but there is no current sale agreement in place. Karen wants to make a gift of a minority interest of 49% in AB Corp. to a trust for the benefit of her spouse and descendants. Because the gifted stock is a minority interest in AB Corp. and is subject to certain restrictions, the gifted stock is valued at $11M (49% of the $30 million value, reduced by a “minority discount” of 25% in this example). One year after making the gift, Karen, as majority shareholder, agrees to sell AB Corp. to a prospective buyer for $50M. The 49% gifted stock is now worth $24.5M due to the post-sale bounce, so Karen effectively removed $24.5M from her estate at a cost of $11M in gift tax exemption. Notice, however, that Karen made the gift well in advance of the sale. If the two events are too close, the IRS could disregard the valuation of the gifted stock at the time of the gift and argue that the value is really the post-sale amount.
Timing is an art in gift tax planning, whether as a result of influences on applicable tax laws, such as the impending presidential election, or because of fluctuations in asset values due to economic, political, and/or global health crisis. The best time to gift is when gift tax exemptions are high and asset valuations are relatively low. Given life’s general uncertainty, and where we find ourselves currently, there is no better time to gift than right now.