If you cringe at the thought of your family paying a 50% or 55% estate tax on the value of your assets upon your death, then you should consider the fact that making major gifts can reduce the amount of transfer taxes paid by your family and increase the value of the assets passing to your children. For example, if you give your children $3 million in assets now, you may be able to save the family $1 million in transfer taxes. Because less taxes are paid to the government, your children wind up with more money in their pockets.
Lower Taxes By Giving
There are two reasons why a gifting program will result in lower transfer taxes. First, all future growth and earnings on the gifted property will be out of your estate after the gift has been made. Therefore, the growth and earnings are not subject to a further transfer tax upon your death. Secondly, even though the tax rates and applicable credit amounts are the same for both the federal gift and estate taxes, the gift tax is paid only on the value of the property gifted. In contrast, the estate tax is levied on all the assets includable in the decedent's estate. In other words, the estate tax is paid on both the value of the property transferred upon the decedent's death, plus the funds which will be used to pay the estate tax. The funds used to pay the gift tax will not be includable in your gross estate, unless the gift was made within three years of your death. As a result, a gift will lower transfer taxes, ignoring appreciation, only if you survive the making of the gift by three years.
The accompanying chart (download below) compares the value of a current $3 million gift and $7 million gift to your children with the value passing to your children at your death if no gifts are made. It is assumed that you and your spouse survive for seven years after making the gift.
The first examples deal with $4,098,000 of property of which $3,000,000 will be gifted and the balance used to pay gift tax, and assumes a 7% after-tax growth for seven years. Under this example, your children would receive almost $1.3 million of greater value through the gifting program as opposed to receiving the same $3 million as an inheritance. Even if you factor in the lost use of the money used to pay gift taxes, your children will net approximately $800,000 of greater value through the gifting program. Note that the examples are based on an Applicable Exclusion Amount of $600,000. The Applicable Exclusion Amount for 2000 and 2001 is $675,000, and for 2002 and 2003 is $700,000. In 2004, it jumps to $850,000.
The gifting program has particular application to the federal generation-skipping transfer tax (GST tax). Each transferor can transfer $1.03 million of property free from the GST tax ($2.06 million, if both spouses split the gift). The proper use of this exemption combined with a gift program can obtain substantial leverage in the value of the asset passing to your grandchildren while minimizing transfer taxes.
If making large gifts now to your children is such a tax-saver, why isn't more of it being done more often? Well, it's being done more than you think. Ultimately, the hardest part of making a major gift to your children is having to write a rather large check to the IRS in payment of the gift tax which will be due next April. However, making the gift now and paying the gift tax might be the best investment you can make. It definitely is one of the most effective planning techniques available when there is anticipated growth in the gifted asset.
Circular 230 Disclaimer
In conformity with U.S. Treasury Department Circular 230 this document and any tax advice contained herein is not intended to be used, and cannot be used, for the purpose of avoiding penalties that maybe imposed under the Internal Revenue Code, nor may any such tax advice be used to promote, market or recommend to any person any transaction or matter that is the subject of this document. The intended recipients of this document are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this document.