Gifting to Avoid Estate and Gift Taxes

U.S. taxpayers are experiencing a "perfect storm" of opportunity to make tax-free transfers (gifts) of assets such as family businesses, real estate and other wealth from one generation to the next. The gift tax was first enacted in 1932 by the federal government after the stock market crash. Over the coming months, we all have what may be the best opportunity since 1932 to gift family assets without a gift tax now and to avoid significant estate taxes later. If you own property depressed in value, the current gift tax situation might provide an excellent time to gift the property to the next generation.

Notable exceptions to the gift tax:

The "gift tax" applies to anything of value transferred by one individual to another. If you gift money or other assets to anyone, the gift tax is always lurking in the background unless an exception applies to the gift.

There are three notable exceptions to the gift tax. One is an "annual exclusion" which is an exception that allows individuals to gift up to $13,000 per year to as many individuals as they want without any gift tax consequences. This exclusion is lost at the end of each year that it is not used. Married couples can split the gifts. For example, if a married couple has three children, and both spouses make an annual exclusion gift to each child, they can gift a total of $78,000 (two spouses x three children x $13,000).

The second exception is for "qualified transfers" that allows for the payment of an unlimited amount of educational and medical expenses, provided the payment is made directly to the educational or medical provider. A third exception is an overall gift tax exemption which historically has been limited to $1 million during an individual's lifetime. For 2012, it is $5,120,000. This limit applies to all taxable gifts made during a person's lifetime and also to the estate of a deceased individual for federal estate tax purposes.

The "perfect storm" of opportunity is almost certainly short-term in nature, and several key elements have transpired to create this opportunity:

– At the conclusion of 2010, Congress changed the estate tax exemption which allows for transfers of gifts up to $5 million per individual ($10 million per married couple) for 2011 and $5,120,000 for 2012, with no federal gift tax.

– Asset values, particularly for real estate, are still significantly depressed.

– Most transfers that are made to take advantage of the gift tax exemption also provide significant asset protection for the assets. Many of our Cottage Law clients with family cottages will be able to enjoy long-term tax savings as a result of taking advantage of this opportunity to make tax-free transfers (gifts) of these legacy assets.

An appropriate gifting strategy can save significant taxes

Why act now? Unless Congress and President Obama take further action to create a new law, the 2010 Tax Act will automatically expire at the end of this year. The current lifetime gift tax exclusion of $5 million per person will drop to $1 million. The window of opportunity for gifting significant assets from one generation to the next to avoid potential future estate tax is narrowing.

The valuation of a gift for gift tax purposes is its fair market value. If the fair market value of the asset you are gifting is depressed, you are making a smaller gift and this leaves more value available for other assets that you may wish to gift also. Gifting assets removes the asset's value from the transferor's estate for estate tax purposes, including any future appreciation of the gifted asset's value, which will grow tax-free. As a result, an appropriate gifting strategy can save significant taxes. The recipient of the property is receiving not only the asset, but also the grantor's tax basis in the asset.

An informed decision as to the gifting of assets might include a comparison of the tax advantages of gifting, with a carryover basis, and the advantages of selling the property, with a stepped-up basis. This means that income tax and estate tax implications should be considered.

Dan Penning is the founder of The Penning Group Advisors & Attorneys and Heather Brenneman Miles is an associate attorney with the firm.

The Penning Group works primarily in business succession planning, real estate and property tax appeals and related matters for individuals, families and business owners. Contact them at 271-4500; or