Prior to the substantial increase in the lifetime exemption amount, lifetime gift planning was a popular estate planning technique. In today’s estate tax environment, however, most advisors may not believe that such lifetime gift planning is required for most of their clients. But, estate planning techniques that involve making lifetime gifts, even today, are still very much alive. Some of these include the following: For those clients who –

• May still be subject to the estate tax at death;
• May want to engage in Medicaid planning;
• May want to provide for their loved ones during their life; and
• May want to decrease the size of their estate for easier estate administration after death.

Part 1 of this post will focus on a brief overview of the similarities and differences in making annual gifts as opposed to lifetime exemption gifts. Then, Part 2 of this post will focus on the above circumstances as to why someone may choose to make lifetime gifts even in today’s tax environment.

Annual Gifts

The annual gift exclusion is currently $14,000 per year for any and every recipient. This means that a taxpayer may give up to $14,000 per year to each and every person they wish. Furthermore, if the taxpayer is married, their spouse can consent to splitting the gift. This means that the married couple may give up to $28,000 per year to each and every person they wish.

A few important items to note regarding annual gifts include the following:

• Any gift up to $14,000 (or $28,000 for a married couple) does not count towards your lifetime exemption amount. This means that you can give away up to the annual exclusion amount each year to as many people as you wish and never diminish your lifetime exemption amount.

• Any gifts given up to the annual exclusion amount will be excluded from your estate. This means that they will not be counted as part of your estate after your death when determining whether or not you are subject to the estate tax.

• Any appreciation on that gift will also be excluded from your estate. This means that if you gift a stock worth $100 to your child and, later, at the time of your death, the stock is now worth $150, not only will the $100 be excluded from your estate, but so will the $50 in appreciation ($150-$100).

• Any gifts will have a carry-over basis to the recipient of the gift. This means that if you bought a stock at $100 and then, later, gift it to your child when it is worth $150, the child’s basis in the stock will be the same as yours, $100. This would result in $50 in capital gains subject to capital gains tax rates if your child were to later sell the stock ($150-$100).

• Gifts may be made to either individuals or trusts (i.e., Crummey Trusts). It is important to note here that in order for the gift to be made to a trust for the benefit of someone, it must be a present, complete gift – see my previous blog post regarding Crummey Trusts. Also note, for example, that if you gift $14,000 to a Crummey Trust for the benefit of your child, you may not also use the annual exclusion amount to gift $14,000 outright to that same child in that same year. Whether the gift is given outright to your child or to a Crummey Trust for the benefit of your child or a combination of both, the maximum amount you can gift in 2014 is $14,000 to that child; that is, if you do not want to exceed the annual gift exclusion amount.

• Any gifts made below or up to $14,000 do not require you to file an annual Gift Tax Return – Form 709. If the gift made to any one individual is greater than $14,000 in a single year, then a Gift Tax Return would be required to be filed.

• If the annual exclusion amount for one year is not used, it does not carry over to the next year; if you don’t use it, you lose it. However, you will still be able to use that next year’s annual exclusion amount to make gifts.

Lifetime Exemption Gifts

The lifetime exemption amount in 2014 is $5.34 million ($5.43 million in 2015). This means that over and above the annual exclusion amount each year, you can gift up to $5.34 million during your lifetime without being subject to the gift tax. If you ever gift above this exemption amount during your lifetime, then you will be subject to a 40% gift tax. It is important to note that this is assessed against the gift giver; the one receiving the gift will not be subject to the gift tax (but may be later subject to the income tax or estate tax).

A few important items to note regarding lifetime exemption gifts include the following:

• Gifts may be made to either individuals or trusts. Similar to annual gifts, you cannot exceed the lifetime exemption amount without being subject to the gift tax; how you spread out that exemption amount is completely up to you though. This means that you could give $2 mil to your daughter outright, $2 mil to your son outright, and $1.34 mil to a trust to be held for the benefit of your son and daughter. Also note that similar to annual gifts, special rules apply to trusts receiving gifts.

• Any gifts made above the $14,000 annual exclusion amount (or $28,000 for a married couple) will count towards your lifetime exemption amount. This means that if in 2014 you give $114,000 to your child, $14,000 of the gift will be offset by the annual exclusion amount and $100,000 will offset your lifetime exemption amount, bringing that lifetime exemption amount down to $5.24 million.

• Any gifts given will be excluded from your estate. However, any gifts given above the annual exclusion amount will be counted against your lifetime exemption amount at your death. This means that if in 2014 you gifted $5,354,000 to your child, $14,000 of the gift would be offset by the annual exclusion amount and $5.34 mil would offset your entire lifetime exemption amount but no gift tax would be assessed. However, when you later die, that $5.34 mil gift that offset your entire lifetime exemption in 2014 will also offset whatever the lifetime exemption amount is in the year of your death. Therefore, if you later died in 2015, you would only have $90,000 remaining for your lifetime exemption amount ($5.43 mil – $5.34 mil). Thus, any assets left in your estate at death above that $90,000 would be subject to the estate tax.

• Any appreciation on that gift will be excluded from your estate and not count towards your lifetime exemption. This means that if you gift stock worth $5.34 mil to your child and use your entire lifetime exemption amount to do so tax-free and, later, at the time of your death, the stock is now worth $10.34 mil, only the $5.34 million will offset your lifetime exemption and the $5 mil in appreciation will not be included in your estate and will escape estate tax liability at your death.

• Any gifts made will have a carry-over basis to the recipient of the gift. This means that if you bought stock at $1 mil and then, later, gift it to your child when it is worth $1.5 mil, the child’s basis in the stock will be the same as yours, $1 mil. This would result in $0.5 mil in capital gains subject to capital gains tax rates if your child were to later sell the stock ($1.5 mil -$1 mil).

• Any gifts made above the $14,000 annual exclusion to any one person will require you to file an annual Gift Tax Return – Form 709. However, no tax will be due as long as you have not used up your entire lifetime exemption amount.

• The lifetime exemption amount is just that, a lifetime exemption. Once it is used up, it is gone. However, under the current law, it increases each year (i.e., it is indexed for inflation). This means that if in 2014 you used up the entire $5.34 mil lifetime exemption, in 2015 you would receive another $90,000 in lifetime exemption because of the increase to $5.43 mil.

• When you die, if you have not used up your entire lifetime exemption amount, your surviving spouse may elect to “port” your lifetime exemption amount. This means that if you die with $5.34 mil of unused lifetime exemption (i.e., your entire estate goes to your surviving spouse so that you don’t have to use any of your exemption), and your surviving spouse ports your lifetime exemption, the surviving spouse’s lifetime exemption in 2014 would then be $10.68 mil ($5.34 mil + $5.34 mil). Note that there are many different rules and strategies as to why a couple may or may not use portability, which will be discussed in a later blog post.

Conclusion

As you can see from the summary discussion above, there are many similarities, differences and little quirks to consider before making annual gifts and lifetime exemption gifts. Part 2 of this post will focus on some of those considerations and the different circumstances in which you may still want to consider and advise your clients to make lifetime gifts, even in today’s tax environment.

Happy Holidays!

-Matt

© 2014 Matthew D. Brehmer and Crummey Estate Plan.