Giving away a substantial sum or valuable asset to a beloved heir may be fulfilling, even fun. But it shouldn’t be just a hobby; it’s serious business. Everyone who’s built up some wealth needs a well-thought-out gifting strategy — both for estate planning purposes and for minimizing the taxes they and their loved ones could face in the here and now.
Recognize the changes
Earlier this year, the American Taxpayer Relief Act of 2012 (ATRA) finally brought some certainty to gift and estate planning. Namely, it retained the 2012 gift, estate and generation-skipping transfer (GST) tax exemptions, but indexing them for inflation. That means, for 2013, the exemptions have risen to $5.25 million.
Meanwhile, ATRA increased the top gift, estate and GST tax rates by five percentage points to 40% — a nominal increase compared to the 20 percentage point hike that had been scheduled.
Although the rates increased, the higher exemptions and clarity of the law are refreshing changes. Even if you maxed out your exemptions in 2012 to lock them in, you’ll now have more exemption available in the future. Plus, that top gift tax rate is still low from a historical perspective.
Give what you can
Any assessment of your current gifting strategy should first consider taking full advantage of your gift tax annual exclusion, which, beginning in 2013, has increased from $13,000 to $14,000 per year per recipient.
Next, consider using some or all of your remaining $5.25 million exemptions via outright gifts to your children or grandchildren. While doing so will reduce the estate tax exemption (and, generally, in the case of gifts to grandchildren, also the GST tax exemption) available at your death dollar-for-dollar, both the gifted assets and any future appreciation on them will be removed from your taxable estate.
Finally, consider how much the assets in question are worth. Stock shares and real estate may have dipped in value recently. This may enable you to transfer more shares or a larger piece of real estate within the exemption.
Step into a vehicle
If you’d like to maintain some control over gifted assets or enjoy enhanced tax benefits, you might want to step into a gifting vehicle. Two common examples are a family limited partnership (FLP) and a family limited liability company (FLLC).
These essentially allow you to transfer assets — and not just business interests — to family members while maintaining managerial control over the entity formed. What’s more, valuation discounts can let you minimize or even eliminate gift taxes.
The primary risk is that the IRS will challenge the validity of the entity and assess back taxes and penalties. So properly structuring and operating an FLP or FLLC is critical.
Another gifting vehicle to ask about is a trust. Grantor-retained annuity trusts and charitable lead annuity trusts, for instance, can let your heirs receive “remainder interests” after annuity payments have ceased, which can provide significant tax savings. Like FLPs and FLLCs, however, trusts must be carefully designed and maintained.
Don’t be a hobbyist
With some certainty finally added to the landscape, now is a good time to make or revise your gifting strategy. To ensure you don’t fall into the category of “hobbyist,” work with your tax advisor and attorney.