In terms of federal tax law changes, a lot happened last year but little changed. Several proposals circulated in Washington, including requiring the receipt of benefits upon death, reducing the federal transfer tax exemption, increasing the estate tax rate, eliminating the assessment exemption, and undoing the benefits of irrevocable grantor trusts.
As it stands, it is anyone’s guess whether these proposals will ever become law. But they are also unlikely to disappear, as many of them persist for years.
Going forward, this can make it difficult to advise clients about the best approach to money transfers. The default position for many advisors is to give advice based on the rules as they are. But for clients who are looking at years or decades as their potential duration of money transfers, the current rules may appear to be an inadequate reference in optimizing their decisions.
Alternative approaches to many other advisors are to engage in various forms of contingency planning, including spouse’s lifetime use trusts, disclaimer plans and other arrangements for potentially escaping if tax laws change (or not) or the client’s needs. Transactions of needs or desires. While this may be good planning in many cases, it often involves complexity that the client would otherwise avoid and will require attention from future administration.
In this context, below are five situations when the current $16,000 gift tax annual exclusion is likely to make sense for taxable gift customers, despite the ongoing potential variability of our federal transfer tax laws. These situations are not the only times when making a taxable gift makes sense, but they can help you know a good candidate for gift giving when you see it.
1. Customers who want to give gifts. If a client wants to make a taxable gift, the question for the advisor is whether there is a tax reason to withhold them.
Customers may want to give a taxable gift to the child to help them buy a home or start a business. They may want to bring a child into the ownership of a family business or property management. They may want to give the child an asset to foster learning and responsibility. They may just want to share their wealth in a way more substantial than the $16,000 annual exclusion.
Under current rules, it is hard to argue that a customer should delay a transfer for tax purposes that otherwise achieves a clear personal or family goal. The federal gift tax exemption is the same as it was before. Rates are relatively low. And a range of planning strategies are still available that advisors can help a client make the most of.
If a customer has not used their full gift and estate tax exemption amount of $12.06 million, the only tax downside may be filing a gift tax return. Even if a customer has used up their full exemption, has paid gift tax now at 40%, and is potentially saving future taxes by reducing the size of their assets, nothing can happen for which they are sorry.
2. Ignoring the step-up in customer base. main tax reasons No Making a taxable gift is a step based on income tax. Under the existing rules, the property transferred on death is generally increased by one step on the basis of income tax based on the value at the time of death. In contrast, property transferred by gift does not.
Customers should be aware of the step-up and its potential tax implications. If a client wants to gift a $2 million property with a $100,000 tax base, they need a warning. Along with the assets, they will pass on an embedded capital gain of $1.9 million. If instead they wait and leave the estate upon death, those benefits cease.
But a client can reasonably respond to your warning that waiting to leave the estate upon death involves a lot of speculation. Even a customer in his 90s can still live another decade. In that period, the step-up could disappear, or the rule could change, as the proposals made clear in 2021. Meanwhile, there would be no personal and tax benefits of gifting.
For these reasons, a customer may decide to ignore the sacrifice of steps that comes with giving the gift of a lifetime. If that’s the case, making a taxable gift usually makes sense for tax purposes, as it takes the asset out of the client’s estate and future appreciation in the hands of their beneficiaries.
3. Customers with fast appreciating assets. main tax reasons To Making a taxable gift is appreciation. For clients with estates that exceed the estate tax exemption, there is 40 cents of tax savings for each dollar of appreciation in the hands of their beneficiaries, rather than a share of their estate.
With property appreciating rapidly, giving early makes all the difference. For founders and entrepreneurs, that may include start-up interests. For fund managers, this can include interests in new funds. Executives can double the growth in hopes of acquiring and delivering stock for their company.
Appreciation can also occur through the accumulation of gifts over time. The value of partial interests in a property will be revealed when the client relinquishes control or that last sliver gives full ownership to his beneficiary.
A one-million dollar gift that appreciates 25% annually on a nominal basis can outweigh the potential sacrifice of a step-up in four to five years. From there, the total tax savings will just compound. In addition, strategies such as selling to a grantor-retained annuity trust and an irrevocable grantor trust can further increase your opportunities for tax savings, sometimes even without a taxable gift.
4. Customers with large estates with high-base assets who have not used their full exemption amount. Under current rules, the federal estate, gift and generation-skip transfer tax exemption amount is set to be halved in 2026. If a customer hasn’t used up their full amount at that time, they’ll lose it as the law stalls a customer who makes a taxable gift of $12 million today before the exemption amount falls to, say, $6.5 in 2026. Million, on paper, saves an additional $5.5 million in tax on assets that they managed to move tax-free.
But keep in mind that the tax savings of using that “bonus” exemption fade to the extent that the exemption amount continues to adjust with inflation. Furthermore, if the exemption is not cut in half in 2026 (or only cut to increase again), using the “bonus” exemption today may not result in the end of the bonus.
The ultimate benefit of using the “bonus” exemption is the uncertainty over why the use of higher-basis assets is important. If a customer gifts cash or other high-basis assets, the step-up basis minimizes the potential tax cost of the relinquishment and the potential tax benefit of using the “bonus” exemption. Moving the appreciation out of the client’s assets, all becomes gravity.
Gifting a lower basis asset can also be beneficial. However, this requires a closer look at the numbers, as the potential tax cost of sacrificing the step-up would be outweighed by the potential tax benefit.
5. Customers who are sure that their tax burden is only going to increase. If a customer is certain that their tax burden is only going to increase, another way of looking at it is that the rules today appear to be quite favorable. If the rules favor today, it makes sense to use them by making them a taxable gift.
Giving gifts can be a way to spread income among family members. Giving a gift can be a way to avoid having an asset subject to estate tax or mark-to-market capital gains rules. Gift-giving can also be a way to set up structures such as irrevocable grantor trusts or family limited partnerships that may involve additional complications or less tax benefits in the future.
Customers who give this type of gift are likely to be aware of the speculative nature of their effort, as well as the risk that they apply today could be undone by tax regulations in the future. Still, their speculation may align with other personal or financial goals — and the more simple tax benefits of gifting — to make it worthwhile.
The uncertainty of what the transfer tax rules will be five, 10 or 55 years in the future cannot be resolved. But in terms of taxable gifts, we can help our customers by knowing the factors that can make sense for their gifts regardless of the regulations.
It can help us avoid pretense like rules are set in stone. It can also prevent us from making complex plans to clients that they may not be equipped to manage as rules develop.
Brian Kirk is the Director of Estate and Financial Planning at Fiduciary Trusts International.