1. How can I reduce my estate taxes by making lifetime gifts?
Making lifetime gifts of assets that would otherwise be subject to
federal estate taxes to your children and grandchildren can dramatically
reduce or even eliminate estate taxes. You can avoid the estate tax that
may deprive your beneficiaries of as much as 40% of their inheritances
by using these features of the federal estate and gift tax laws:
a. The $14,000 Annual Exclusion. Each
individual can give up to $14,000 per year per recipient without gift
tax consequences and without filing a gift tax return. The number of
possible recipients is unlimited. This means that a typical couple with
two children can give up to $56,000 per year to their children under
this exclusion. An older couple with two married children and four
grandchildren can give up to $224,000 per year in this fashion if the
children's spouses are included. The unused portion of your annual
exclusion in any one year is lost forever; it cannot be carried forward
into the next year. To qualify for the annual exclusion, a gift must be
a gift of a "present interest", which is discussed in Section
4. The $14,000 amount is indexed to inflation and will increase in
b. The Unlimited Exclusion for Educational and Medical Expenses.
In addition to and entirely separate from the $14,000 annual exclusion,
there is an unlimited gift tax exclusion for payment of another person's
educational or medical expenses. To qualify for this exclusion, the
payment must be made directly to the service provider (the hospital,
doctor, or educational institution). Reimbursing a person for expenses
already paid does not qualify for this exclusion. The exclusion for
payment of educational expenses is limited to tuition only, and does not
include books, supplies, dormitory fees, etc. This is a perfect way for
grandparents to make a valuable, tax-free gift to their grandchildren.
Medical expenses can include payment of medical insurance premiums, but
do not include expenses that are not deductible for income tax purposes
(such as elective surgery for purely cosmetic reasons).
c. The Applicable Exclusion Amount
(formerly the "Unified Credit"). Each person has an estate
and gift tax exemption (called the "applicable exclusion
amount" under current tax law) that allows up to $5,430,000 worth of assets to be
transferred during his or her lifetime or at death.
portion of your applicable exclusion amount not used during your
lifetime would be used at death. Gifts using your applicable exclusion
amount can be made in addition to gifts using your $14,000 annual
exclusions and the exclusion for educational and medical expenses. Many
clients do not use their applicable exclusion amount during their lifetime, but early
use of the applicable exclusion amount has numerous advantages. First,
increases in value of gifted property and the income earned on the
property will not be subject to gift or estate taxes. Second, if
Congress ultimately reduces the applicable exclusion amount then any
reduction may be "grandfathered" so it doesn't apply
to gifts made before the law changed.
d. Gift-Splitting Between Spouses. When a gift is
made by a married person to a third party, the spouse of the donor may
allow the gift to be treated as if it was made one-half by each spouse.
This gift-splitting is effective for both use of the annual exclusion
and the applicable exclusion amount. For example, assume that Wife owns
a $28,000 vacant lot that she wants to give to Child. Without
gift-splitting, this would exceed her $14,000 annual exclusion and
$14,000 of her applicable exclusion amount would be used. If Wife and
Husband elect to split the gift, then the gift is treated as having come
one-half from Husband even though Wife is the sole owner of the
property. The gift would be within the couple's combined annual
exclusions, and Wife's applicable exclusion amount would not be used.
To qualify for gift-splitting, the couple must be married at the time
of the gift, and must file a timely gift tax return (IRS Form 709)
signed by both spouses consenting to the gift-splitting. The election
will apply to all gifts made by either spouse while the couple is
married during the year for which the return is filed. Gift-splitting is
not available for property passing at death.
e. Post-Gift Appreciation Is Not TaxedWhen you make a lifetime gift, it is valued as of the date of the
gift for gift tax purposes. Estate tax on property left upon death is
generally figured on date of death value. This means that any post-gift
increase in the value of the property has been transferred free of
estate and gift taxes. As an extreme example, we know of people who
given stock in a company they helped found to their children during the
company's early years when the stock was worth very little. A few years
later, the company went public. The stock price skyrocketed, and made
the children millionaires while still in their teens. Through their
foresight, the parents were able to transfer this stock to their
children at little or no estate or gift tax cost and saved hundreds of
thousands of dollars in potential estate taxes.
2. How much estate tax can I save by initiating a lifetime gift
Following a gift program can save substantial estate taxes, even if
you only use annual exclusion gifts.
Assume that John and Jane Doe have two children and four
grandchildren, and assets of $15 million. If John dies in 2020 and Jane dies in 2025, and the estate tax
applicable exclusion amount has not been increased for inflation after 2015, then estate taxes of
approximately $1,656,000 will still be imposed upon Jane Doe's death , even with no appreciation in their assets!
If John and Jane Doe make annual exclusion gifts of $14,000 per year
to each of their children, their children's spouses, and grandchildren, they can each give up to
$112,000 per year. Based on the above facts, if these annual gifts commence in 2015, they will reduce the
taxable estate of the surviving spouse by $1,680,000, reducing estate
taxes by $672,000.
3. How can I be sure my children won't frivolously waste my gifts?
Despite the tax advantages of making lifetime gifts, many parents are
apprehensive about making substantial gifts to their children.
They fear that the children will fritter away the money that the
parents worked very hard to earn. They're afraid that if the children
receive the money before they are mature, they will lose the drive and
initiative to be successful in their own right.
These concerns can be addressed by structuring the gift properly.
There are four common methods used to make gifts:
1. The first is an outright gift, which gives the recipient
complete control and leaves the gift vulnerable to the recipient's
If the recipient is at least 18 and has earned income, a gift can be
made as a contribution to a traditional or Roth IRA in the recipient's
name. While the child would have the right to withdraw the
contribution from the account, the resulting income tax penalties may
discourage such action.
2. If the gift is to a minor child, a second way is to
make the gift to a
custodian of your choice under the Florida Uniform Transfer to Minors
Act. Under this Act, the custodian controls the money or property
until the child turns 21. At this point, the accumulated gifts must as a
matter of Florida law be distributed outright to the child all at once.
One advisor has called this law the "Uniform Sports Cars to
21-year-olds Act." Also, a gift to an UTMA account may require
filing separate income tax returns for each child.
While it is possible to transfer assets to yourself as custodian for
a child, please be aware that such assets will nevertheless be subject
to estate taxes if you die while serving as custodian. A
third party should therefore be named as custodian to avoid estate tax
3. A third way to make gifts is to make contributions to a Section
529 Plan for your children's future education. Significant income
tax benefits are achieved so long as the funds are used for qualified
education expenses of the beneficiaries.
4. The fourth way is to establish a trust for the beneficiary (called
a "Gift Trust') to hold the gift under the terms that you,
as Grantor of the Trust, determine and set forth in the trust
instrument. You can dictate how much the beneficiary receives, when it
is received, and the purposes for which a distribution can be made. You
can choose a trusted person or persons to be Trustee and can retain the
right to replace the Trustee for any reason. You can also give the
Trustee discretion to withhold distributions if the Trustee thinks it's
in the beneficiary's best interest at the time. You can provide that the
Trust assets could be used for college and graduate school expenses, a
first home, or to start up a new business. You can even provide that the
beneficiaries receive nothing until after your death. Because a Gift
Trust contains spendthrift and anti-alienation clauses, any
undistributed property in the Trust is generally immune from your
Clients often use family limited partnerships or family
corporations whereby the client can control the entity and its
assets, but can give partial ownership interests without control rights
(e.g. limited partner interests in a limited partnership or non-voting
stock in a corporation) to their children, grandchildren, or to Gift
Trusts established for their children and grandchildren.
4. Do gifts to a Gift Trust qualify for the annual exclusion?
As previously mentioned, to qualify for the annual exclusion, a gift
must be a gift of a "present interest," which simply means
that the recipient must either receive or have the right to receive the
gifted property at the time of the gift. This is not a problem for
outright gifts or gifts under the Uniform Transfers to Minors Act, and
the tax law specifically provides that contributions to Section 529
plans qualify, but can be a problem for gifts in trust. Gifts in trust
do not qualify for the annual exclusion unless the trust either
qualifies as a "Minor's Trust" under Internal Revenue Code
Section 2503(c) or has certain temporary withdrawal powers called "Crummey"
powers. To qualify as a "Minor's Trust," the beneficiary must
receive or have the right to receive all of the property in the trust
outright at age 21. This generally makes the Minors Trust unpopular for
A "Crummey" power gives the beneficiary a temporary right
to withdraw the gift from the Trust. The beneficiary is given written
notice of the gift to the Gift Trust and has a specified time, usually
45 or 60 days, to elect to withdraw the gift. If the beneficiary fails
to exercise this right, then it lapses and the gift stays in the Trust
Gift Trusts using "Crummey" powers offer maximum
flexibility. There is no specified age at which the beneficiary must
receive the property except the age or ages that you select. A typical
arrangement is to have the trust property distributed 1/3 at age 25,1/3
at age 30, and the rest at age 35, but you may leave the property in
trust until the beneficiary reaches age 50 or even older if that is what
you wish. You can give the Trustee discretion to change the ages as you
wish. More and more clients are realizing the creditor protection and
tax planning advantages of having assets
held in trust and provide that each child's assets will remain in
trust for his or her entire lifetime, with the child serving as sole
Trustee at an age determined by the client. You can give the Trustee the
power to invade the shares of less needy beneficiaries for the benefit
of more needy beneficiaries. You can even have the trust be a generation
skipping trust (also called a "dynasty trust") so that the property stays in trust for up to 360 years,
to provide benefits to each succeeding generation while not being
subject to estate taxes in their estates.
5. Who can be the initial Trustee of my Gift Trust?
A Grantor may not be the Trustee of a Gift Trust, but can
retain the right to replace the Trustee at any time. A person who is
also a beneficiary of the Trust (for example, a responsible eldest
child) may serve as Trustee, if the Trust is specially drafted. If only
one spouse is making gifts to the Trust, then the other spouse may serve
as Trustee, although it is typically preferable to have a third party
The Trustee can be a family friend or relative. A bank or trust
company may also serve as Trustee. For a larger Trust, an individual and
a bank or trust company could serve as co-Trustees, with the individual
Trustee having the power to replace the bank or trust company.
6. How much control can I maintain over my Gift Trust once it is
A Gift Trust is irrevocable. After it is established you cannot
revoke the Trust or modify its terms. The key is to make sure the Trust
document provides adequate flexibility. For example, the Trustee should
be given the discretion to withhold distributions it deemed in the
beneficiary's best interest, and should have discretion in other key
Under IRS Revenue Ruling 95-58, you can now retain the power to
replace the Trustee, so long as the replacement trustee you select is
not "related" or "subordinate" to you. Most clients
find that this ability gives them adequate control over the Trust.
Your Trust can also include the appointment of trusted independent
persons as "Trust Protectors" who would have the authority to
replace the Trustee and modify certain Trust provisions if necessary.
7. How can using a Gift Trust allow me to transfer more to my
children that I would be able to do so using an outright gift?
A Gift Trust can include a "grantor trust" power that would
cause you to be considered as the owner of the trust for income tax
purposes even though the property has been gifted and will not be
included in your estate for estate and gift tax purposes. This means
that, as Grantor, you would pay the income tax on the Trust's income on
your personal Form 1040. This payment of the Trust's income tax is not
considered an additional gift to the Trust under current law.
By using this technique, you allow the property in the Trust to
compound income-tax free which, over a number of years, could greatly
increase the value of the property in the Trust (and out of your
estate). For example, assume that $100,000 is contributed to a Gift
Trust that is a grantor trust, and that it generates income equal to 10%
of its assets per year which is taxed at a tax rate of 30%. If the Gift
Trust paid the taxes on the Trust income, then at the end of 10 years,
the Trust would have assets worth approximately $196,700. If the Grantor
pays the taxes, then the Trust assets at the end of the same 10-year
period would be almost $259,400, meaning that an additional $62,700 in
assets would avoid being subject to estate tax, saving almost $25,080 in
estate taxes assuming the 40% rate applies.
There are also potential income tax savings if your marginal income
tax rate is less than the Trust's. Trust income tax rates are very
compressed, reaching the top marginal rate of 39.6% at only $12,300 of
income in 2015.
Of course, if you wish to use a grantor trust, a cash flow analysis
should be performed to ensure that you have the cash to pay the taxes on
the trust income. If the Trust is properly drafted, the grantor trust
power can be released or terminated at any time, so that all future
income would be taxed to the Trust rather than to you.
8. How can using a Gift Trust save my family substantial income
taxes, as well as estate taxes?
A problem with making outright lifetime gifts of assets that have
appreciated in value or that can be expected to appreciate after the
time of the gift is that you lose the "step-up" in income tax
basis to date of death fair market value under Internal Revenue Code
Section 1014 that currently applies to assets that you own at death.
Here's how the basis step-up works. Let's say that you bought
$100,000 of XYZ stock in 1990. The stock is now worth $200,000, and you
think it will go up to $500,000 during your lifetime. If you leave the
stock to your children at death, then they have a "stepped-up"
income tax basis equal to the fair market value as of the date of your
death (i.e., $500,000). If they sell the stock for $500,000, they pay no
capital gains tax, but there may be estate tax payable on the entire
$500,000. However, if you give the stock to your children outright now,
then then they will have a "carryover" income tax basis of
only $100,000, and if they sell the stock for $500,000, then assuming a
capital gains tax rate of 20%, they will have to pay capital gains taxes
of $80,000 ($500,000 amount received - $100,000 basis = $400,000 capital
gain x 20% tax rate = $80,000 tax).
However, by making a lifetime gift of the stock to an Irrevocable
Gift Trust that is a grantor trust, this problem can be avoided. This is
because a commonly used "grantor trust" power is a power in
the Gift Trust instrument that allows the Grantor to substitute trust
assets with other assets of equal value.
If you make the gift of XYZ stock to a Gift Trust with this grantor
trust power, then you have the ability to replace this stock with cash
or high-basis assets at any time during your lifetime, so long as the
value of the replacement assets is equal to the fair market value of the
XYZ stock at the time of the replacement. In this example, when the XYZ
stock is worth $500,000, you could get it back from the Gift Trust by
replacing it with $500,000 cash. Upon your death, you would own the XYZ
stock, which would receive a stepped-up basis, while the $500,000 cash,
which replaced the XYZ stock which had been transferred based on a
$200,000 value, would pass estate tax-free to your children.
Transactions between you and a grantor trust of which you are the
grantor are ignored for income tax purposes and therefore do not trigger
capital gains, under IRS Revenue Ruling 85-13. The
existence of "Crummey" withdrawal rights may make the Gift
Trust not a grantor trust in part, and any proposed asset replacement should be
carefully analyzed by the appropriate tax professionals at that time to
avoid inadvertent capital gains tax recognition.
9. After establishing a Gift Trust, will I have to make
contributions every year?
No. You can stop making annual gifts into the Trust at anytime, and
can restart at any time. However, the annual exclusion is a
"use it or lose it" proposition, and unused exclusion amounts
do not carry forward into future years.
10. How can I use a Gift Trust to make gifts that can benefit my
children for their lifetimes and can then pass to my grandchildren or
succeeding generations without being subject to estate tax in my
Each person has an exemption from the federal "generation
skipping transfer" (GST) tax, which is otherwise imposed on gifts
or bequests to grandchildren and younger generations at a rate equal to
the maximum estate tax rate in
addition to any estate or gift tax imposed. The GST exemption for 2015 is
$5,430,000. If a Trust is established using all or a portion of this
exemption, the assets in the Trust can be distributed for valid purposes
such as health, education, and reasonable living expenses, or whatever
purpose you determine, to your children, grandchildren, and succeeding
generations. Any undistributed amounts will not be subject to either
estate tax or generation skipping tax in their estates, no matter how
many generations the Trust lasts. A Trust of this sort can last for 360
years or more under a new Florida law and can potentially save vast sums
of estate taxes over many generations. A Dynasty Trust (also called a
"Generation Skipping Trust") of this sort is something to be
seriously considered as part of your estate plan, particularly if your
children are wealthy enough to be concerned about their own estate
taxes. While a Dynasty Trust can be set up either during life as an
Irrevocable Gift Trust or Irrevocable Life Insurance Trust, or at death
under the terms of your Living Trust, the GST exemption with respect to
lifetime transfers to a Gift Trust or Life Insurance Trust applies to
the fair market value of the gift as of the date of the contribution, so
any increase in value after the gift will not use any further GST
There is also a $14,000 annual exclusion from the GST tax. Gifts to
grandchildren or great-grandchildren qualifying for this exclusion will
not use any of your GST tax exemption. A specially drafted Gift Trust
for grandchildren will qualify for the GST annual exclusion as well as
the gift tax annual exclusion.
11. How can using a Family
Limited Partnership enable me to leverage my gifts?
A gift of a limited partnership interest may be valued for gift tax
purposes as being worth significantly less than an outright gift of the same amount
of underlying assets because of valuation discounts due to lack of
marketability. The availability and amount of the appropriate discount,
if any, would need to be evaluated on a case-by-case basis and the
services of a professional appraiser are strongly recommended. If a 25%
discount were found to apply, for example, you could
theoretically gift $18,667 in partnership interests per donee per year
(instead of only $14,000 in cash or other property), and still be within
the annual exclusion.
12. In what other ways can I leverage my gift program?
There are several kinds of specialized Gift Trusts and other
transactions that can be used to leverage your gifts. These planning
tools generally involve you receiving an income interest or a series of
payments over a period of years or for your lifetime, or that of you and
your spouse. The value of the transfer for gift tax purposes is reduced
and can even be eliminated in some cases due to this retained interest.
These tools include Qualified Personal Residence Trusts, Grantor
Retained Annuity Trusts, Installment Sales to Grantor Trusts,
Private Annuities and Self-Canceling Installment Notes. If you would
like more information about any of these, we can show you how they might
work to save estate taxes in your estate.
13. When is it not appropriate to make gifts?
Obviously, you should not give away property that you may need at
some point in the future. To qualify for the tax advantages discussed
here, a gift must be irrevocable. While it is possible that your
children could return monies to you if the need arises, you should not
put yourself in the situation of having to rely on your children's
Certain states (such as Alaska and Nevada) have enacted laws that
allow you to make gifts to a specially drafted Irrevocable Gift Trust
that permits an independent Trustee to have the ability to make
distributions from the Trust back to you in the Trustee's discretion,
while hopefully removing any undistributed trust assets from your
taxable estate. These special Gift Trusts can be used by Florida
residents, so long as the applicable state statutes are followed.
As a general rule, property which has a low "basis" for
income tax purposes should not be gifted, unless the gift is to a Gift
Trust that is a grantor trust, as discussed above.
14. What is the cost of a Gift Trust?
The cost of a Gift Trust will vary based upon the complexity of its
provisions and the planning involved. It will cost only a fraction of
the estate taxes saved if the gift program is properly carried out.
15. Who should prepare my Gift Trust?
We strongly recommend that an attorney who specializes in estate
planning and taxation be retained to draft your Gift Trust. There are
many important and complex issues that need to be addressed in order to
properly structure gifts, gift trusts, and similar mechanisms.
James F. Gulecas, Esq., is board certified in Tax Law and Wills, Trusts & Estates by the Florida Bar.