Inter-Generational
Generosity
If given the choice, would you rather transfer your wealth to the IRS or
to your loved ones? If you answered the IRS, then disregard this
article. You will find it of little benefit. On the other hand, if you
answered your loved ones, then read on. First, we will review some
of the relevant tax rules for lifetime gifting, then we will examine two
common transfer methods, along with a few of their potential pitfalls.
Gifting
Fundamentals
Every taxpayer may transfer up to $11,000 each
year to an unlimited number of individuals. This is known as the Annual
Gift Exclusion (AGE). Through gift splitting, spouses may give a
total of $22,000 each year to an unlimited number of individuals (even if
only one spouse is the sole source of the funds gifted). Such lifetime
gifts made within these dollar limitations do not trigger gift taxes when
made, nor do they reduce the combined Applicable Exemption Amount
available to protect lifetime transfers of wealth exceeding AGE limits and
post-mortem transfers of wealth. [View the tax
table.] Accordingly, maximizing transfers within the limits of the AGE
has been and remains a prudent method to transfer wealth between
generations. [Exception: Qualified payments in any amount made directly
to an educational institution for tuition and directly to a
provider of medical care on behalf of any individual are fully excluded
from gift tax consideration. They may be made without dollar limitation.]
EGTRRA
Exemption
Under the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA), taxpayers will be able to make total
lifetime tax-exempt transfers of wealth totaling $1 million independent of
the AGE limitations, to include for tax years 2004 and beyond. For
example, in 2004, a widowed taxpayer with five grandchildren could
transfer a total of $1,055,000 to them free of gift taxes. Additionally,
this $1,055,000 would be excluded from the donor's estate for
determining any future estate tax liability, as would any future
appreciation on the gift. [Note: On the downside, however, the
grandchildren would receive their grandparent's cost basis in the
gift, triggering potential capital gains taxation on the appreciation
above cost basis. Proper estate planning often requires balancing your tax
and non-tax objectives.]
Depending on the size of your overall estate and
your ability to make gifts without affecting your lifestyle, maximizing
your lifetime wealth transfers may be a tax-savvy strategy given the
uncertainty of estate tax repeal beyond 2010. Nevertheless, once you have
made the decision to be inter-generationally generous, the next decision
is how to make the transfer. Two popular methods are outright gifts
and custodial accounts.
Outright
Gifts
An outright gift with no strings attached is the
simplest method of making a lifetime wealth transfer. You simply deliver
the asset directly to the donee. Once in the hands of the donee, however,
your gift may be taken away from them through a divorce, lawsuit or
bankruptcy. More commonly, your gift may be squandered, because you
have no further control over an outright gift once delivery is made. Fact:
No one appreciates the value of a dollar like the person who earned it
(and paid taxes on it). Fortunately, the law provides at least one simple
alternative to protect gifts, particularly when made for the benefit of
minors.
Custodial
Accounts
Custodial accounts established under the Uniform
Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA)
are very popular methods of making transfers to loved ones who are minors.
They are popular because they are convenient and inexpensive to create.
Almost all financial institutions offer such arrangements.
Beware: The account becomes the unrestricted
asset of the beneficiary upon reaching age 18 or 21, depending on
applicable state law. In other words, it could be used for fast cars and
stereos, instead of books and tuition.
Summary
Inter-generational generosity makes good sense
for a variety of reasons. However, great care must be given to the method
of transfer to avoid the potential pitfalls of these do-it-yourself
methods. A Crummey Trust is an alternative transfer method to
consider, especially if you prefer to make gifts with strings attached.
For more information, see our page three article.
The
Crummey Alternative
There
are many non-tax benefits to making lifetime gifts to loved ones, aside
from the obvious tax benefits. For example, what better way to preview the
financial maturity of your loved ones with an inheritance in the future
than through a dress rehearsal in the present…while you are still
in the audience?
Keeping Control
 If you are like most people, you may be reluctant
to part with control over how your lifetime gifts will be used once
transferred. Unfortunately, when you retain direct control over a gift,
the value of the gift (and its appreciation) may be included in your
estate upon your death for estate tax purposes. Worse yet, the gift may be
taxable at the time of transfer as a future interest gift, rather
than treated as a nontaxable present interest gift.
To qualify as a nontaxable present interest gift,
the donee must be able to exercise complete and unrestricted control over
the gift. Fortunately, there are exceptions to this general rule, such as
custodial accounts for minors as described in our front-page article.
Another exception is the Crummey Trust, as created in the landmark
case of Crummey v. Commissioner, 397 F2d 82 (9th Cir.
1968).
Although the Crummey case carved a very narrow exception to the general
rule regarding the present interest requirement for nontaxable gifts, the
path is narrow that leads to safety. Therefore, it is essential for the
success of your Crummey Trust that you dot all of the legal i's
and cross all of the procedural t's. Truly, the devil is in the
details here. [Note: If a Crummey Trust is properly created, administered
and funded with life insurance, then 100% of the eventual insurance
proceeds will be excluded from the trustmaker's estate.]
Crummey Requirements
First, you create an irrevocable trust agreement
(i.e. you cannot change its terms once signed by you) containing all of
the strings you wish to attach to the future gifts to the trust.
Second, you make lifetime gifts to the trustee on behalf of your trust
beneficiary (or beneficiaries). Third, the trustee must provide written
notice to the beneficiary (or their legal guardian, if the beneficiary is
a minor) each time you make such a gift, giving the beneficiary a period
of time (typically not less than 30 days) to exercise their right to
withdraw all or part of the gifted amount.
If the beneficiary does not exercise this
withdrawal right, then the gift lapses and the trustee administers
the gift for the beneficiary according to the strings you attached. These
strings may provide valuable protection for your gifts from divorces,
lawsuits, bankruptcies and squandering. Conversely, if the beneficiary
exercises this withdrawal right, then you may have gained a valuable
insight into their current financial maturity level. In either case, you
may wish to revise your estate plan accordingly.
Summary
This has been a brief overview of a complex
estate planning strategy. The laws concerning lifetime gifting can have
very complex income, gift and estate tax consequences. Always seek
competent legal counsel before committing your resources.
Copyright © 2005 Integrity Marketing Solutions. All rights
reserved. Some artwork provided under license agreement. This
publication does not constitute legal, accounting or other professional
advice. Although it is intended to be accurate, neither the publisher
nor any other party assumes liability for loss or damage due to reliance
on this material.
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