Prospects for repeal of the estate tax became less likely after the November 2006 elections; as a result, gifting continues to be a powerful estate planning tool. Maximizing use of the annual gift tax exclusion, using the $1 million lifetime gift tax exemption and gift-splitting by married couples, can help reduce the size of a taxable estate. The younger the individual using these tools, the better the results.
Current Exclusion/Exemption Amounts
The current annual gift tax exclusion is $12,000 per donee, under Sec. 2503(b)(1). This amount is indexed for inflation under Sec. 2503(b)(2) and could rise in the future. Any annual gift tax exclusion not used in a calendar year is lost; there is no carryover.
The current lifetime gift tax exemption is $1 million, under Sec. 2505. This amount had been tied to the estate tax exemption, but currently is fixed at $1 million, even though the estate tax exemption is scheduled to change in the future (currently under Sec. 2010(c), $2 million for 2007 and 2008; $3.5 million for 2009; full exemption in 2010; and $1 million in 2011).
Reducing the Estate
Annual gift tax exclusion: Making a $12,000 gift will likely reduce the donor’s estate by more than $12,000 (because had the gift not been made, the asset would likely have increased in value).
Example 1: X, a 50-year-old, makes a $12,000 gift in 2007; there is no gift tax because of the annual exclusion. If X lives to age 70, the $12,000 would otherwise have grown to $38,486, assuming a 6% annual rate. Thus, a $12,000 gift made 20 years before death would decrease the total estate by $38,486 (more than 3.2 times the original gift amount). If the gift were made 10 years before death, the estate reduction would be $21,490, approximately 1.8 times the original gift. However, because the $12,000 exclusion is available each year, a consistent gifting plan could result in a significant reduction to X’s eventual estate.
Estate tax exemption: The $1 million estate tax exemption can be used now or later. To the extent that it is used during life to reduce taxable gifts, it is not available for estate tax purposes, making it somewhat less valuable than the annual gift tax exclusion. However, as with annual-exclusion gifts, asset growth from the gift date until death is removed from the estate.
Example 2: Y, 50 years old, makes a $1 million gift in 2007 and elects to use his estate tax exemption; thus, he will not be subject to tax on that gift in 2007. If Y did not make the gift, but left the funds in his estate until death 20 years later, at 6% annually the amount would grow to $3,207,135. However, if Y used his $1 million exemption, the exemption available to the estate would be reduced. The net reduction in the estate would be $2,207,135 (more than 2.2 times the gift amount). If the gift were made only 10 years before Y’s death, the net reduction to the estate would be $790,848, almost 0.8 times the gift amount.
Married couples can double their exclusion and exemption amounts, as each spouse is entitled to both a $12,000 annual gift tax exclusion and a $1 million estate tax exemption. If gifted assets are owned jointly, a gift would be deemed made one-half by each spouse, if the spouses meet Sec. 2513’s requirements. If an intended gift asset is not owned jointly, there are two options. The asset’s owner could transfer a one-half interest to the other spouse before a gift is made to a third party. This would be gift tax free, because transfers between spouses are exempt from gift tax, under Sec. 2523. Alternatively, the nonjoint property could be gifted outright to a third party. The non-owning spouse could elect to split the gift for gift tax purposes, thus being able to use the annual exclusion and/or $1 million exemption. The splitting election requires the spouses to file a gift tax return. Thus, the dollar amounts of estate reduction in Examples 1 and 2 above would double if both spouses maximized use of their annual exclusions and exemptions.
While there are many nontax considerations in making gifts, individuals who project a taxable estate would be well served to take advantage of the exclusion, exemption and splitting provisions in the gift tax rules. The sooner that individuals eliminate the future growth of gifted assets from inclusion in the eventual estate, the more beneficial the results.
Mr. Miller is a member of the AICPA Tax Division’s IRS Practice and Procedures Committee. Mr. Brennan is the chair, and Messrs. Snow and Tierney and Ms. Hodes are members, of that committee. For further information about this column, contact Mr. Miller at email@example.com.