EVEN GIFTS HAVE TAX STRINGS TO THEM

Annual gift giving to children and grandchildren is one of the main strategies people can use to lower estate taxes that range to 45% when an estate exceeds $3,500,000 (as many have read, something will “give” in Washington in 2009 - stay tuned). In 2009, a husband and wife can now each make gifts of up to $13,000 annually in money or other property to as many beneficiaries as they like without incurring any gift tax liability (note this was $12,000 in 2008). Furthermore, pursuant to the uniform gift and estate tax exemption, an individual can make up to $1,000,000 in taxable gifts during his or her lifetime before Federal gift taxes are imposed. Unfortunately, many people make inadvertent errors that defeat the benefit they hope to derive. Common mistakes we at Abo and Company typically learn about during our tax season (it’s here folks) include:

• Making gifts of future interests in property when the intent is to obtain the annual gift tax exclusion.
• Gifting highly appreciated property just before death, thus eliminating the benefit of the step-up in basis on inherited property.
• Failing to make payments for tuition or medical expenses directly to the medical institution or educational provider and instead giving the funds to a child or grandchild.
• Gifting mortgaged property with a mortgage balance that exceeds the adjusted basis of the property.
• Transferring income-producing property to children under 14 since the unearned income in excess of a threshold amount is taxed at the parent’s marginal rate.

An Abo and Company bit of advice - since the rules are complicated, especially as they pertain to property, it is essential that professional tax/legal assistance be obtained before gifts are executed.

We don’t want to get too technical but let’s dig a little deeper since we now all can see from our comments above that people frequently make gifts of property during their lifetime to reduce their estate and lower estate taxes. A common error we, as planners, frequently encounter is that income tax effects are ignored. For example, as our bullet two above noted, when gifts are made of property that has significantly appreciated, the property retains the same basis in the hands of the donee as it had in the hands of the donor, so that when it is eventually sold, there will be significant capital gains taxes. On the other hand, if it had been retained by the donor and inherited by the donee, the basis to the latter would be the value at the time of death. In effect, at the time of a subsequent sale, all of the appreciation that occurred during the decedent’s life would be inherited tax-free. Thus, appreciated property should generally be gifted when the donee is not expected to sell it. This also might be the case with a valuable business interest. Other rules of thumb we’ve seen are to give appreciated property away only to a donee that is in a lower tax bracket than the donor. If a donor is in the same or a higher tax bracket, the property should be sold first, capital gains taxes paid and the proceeds given away by the donor.

The use of gifts and their proper implementation to lower overall taxes is just one more illustration of how a client is best served by a planner who values a multi-disciplined approach to multi-faceted needs. Conversely, disservice is done when a client or planner does not appreciate the interdependence apparent in Abo and Company’s “three legged stool” - tax planning, estate planning and financial planning.