In my last post, I alerted you to the fact that the federal gift and estate tax exemptions— now at a record high of $11.58 million per individual for 2020--would revert back to $5 million per individual (adjusted for inflation) in 2026 and could be cut back much sooner and more dramatically depending upon the results of this year’s election. I urged you not to postpone making lifetime gifts to use up the increased amount. As a follow-up, I thought I should lay out some of the pros and cons of making lifetime gifts.
Pros: Advantages of Lifetime Gifts
One advantage of lifetime gifts is that a regular program of lifetime gifting can substantially reduce your estate tax bill. A current gift of property likely to increase in value during your lifetime not only removes the property from your estate but also removes all post-gift appreciation. If the gift is within your available Federal gift tax exemption— you will have passed all of this value to your children transfer tax free.
Another advantage is the availability of two lifetime “gift-tax free” transfers that don’t use up your gift tax exemption. The first one, called the federal annual exclusion gift, allows you to make tax-free gifts each year to any number of individuals up to a specified amount. For 2020, this amount is $15,000 per recipient ($30,000 for a married couple). The second transfer allows you to make direct payments of tuition or medical expenses on behalf of an individual, free of federal gift tax. These two simple gifting methods when used as part of a regular annual giving program can be a powerful way to reduce your taxable estate.
Lifetime gifts can be made to a trust structured to protect the gifted assets from your children’s spouse or creditors, or to permit you to pay the trust’s income tax during your lifetime without such payments being taxable gifts. This last benefit allows the trust assets to grow income-tax free for the benefit of your children while you are alive, and also reduces your taxable estate. It is also possible for you to gift partial interests in property or minority interests in closely held partnerships or limited liability companies that may qualify for valuation discounts. Such gifts let you “leverage” your exemption or reduce the value of your taxable gift.
Lifetime gifts also have non-tax benefits. The most obvious is to allow the recipient to enjoy the gifted property currently. Making gifts to your children during your lifetime gives you the opportunity to help them master financial responsibility, develop investment acumen, or to learn about philanthropy using their own funds.
Cons: Disadvantages of Lifetime Gifts
One big disadvantage to lifetime gifts is that you no longer have control over the assets you gave away. Note however, that it is possible to structure a gift in trust that allows you access to the gifted property (through a spouse) if you really needed the funds.
Another potential disadvantage may arise with gifts of appreciated property. Property transferred during life retains your tax basis. If you held the property at death, the property would receive a “stepped-up basis” equal to its fair market value on your date of death. That means the recipient could immediately sell the property free of capital gains tax. If the appreciated property you gave away fails to produce a sufficient post-gift investment return to offset the loss of a basis step-up, there would be an overall disadvantage to having made the gift. It is therefore important to weigh the estate tax savings against the potential income tax costs when considering a gift of appreciated property.
State laws may also create disadvantages to lifetime gifts. New York donors should be aware that while New York does not impose a gift tax, it does impose an estate tax on gifts made prior to 2026 within 3 years of death. The New York estate tax paid with respect to such gifts may not be deductible for Federal estate tax purposes.
Berdon can help you weigh the pros and cons of lifetime gifts and help you develop a program of lifetime giving as part of your estate plan. You can reach me at AClapp@BerdonLLP.com or you can contact your Berdon advisor.
Ada Clapp is a Berdon LLP Senior Principal with more than 25 years of experience, as a trusts and estates attorney, wealth strategist, and family office general counsel, advising high net worth individuals, fiduciaries, and family offices on a wide variety of matters. She has extensive experience advising on sophisticated income, gift and estate tax planning, philanthropy, fiduciary advisory and trust administration, family governance and family office operations.