TO GIFT DURING LIFE OR TRANSFER PROPERTY AT DEATH
Clients often ask whether it is better to give property to their children now or transfer it to them on their death. In addition to considering the client’s non-tax objectives, the answer will be shaped by Federal estate and gift taxes and capital gains taxes.
Non-taxable Estate, Transfer By Gift. If the client’s estate will not be subject to Federal estate taxes on his or her death, then:
- the client will have to file a Federal gift tax return if the value of the gifted property is in excess of the annual exclusion amount (currently $14,000). Even though the client must file a gift tax return, he or she won’t need to pay any Federal estate taxes as long as the sum of all gifts given during the client’s life is less than the Federal estate tax exemption amount (currently $5,250,000).
- The recipient of the property will receive the property taking the client’s tax basis. When the recipient sells the property, he or she will pay capital gains tax on the difference between the sales price and the client’s tax basis. For example, if the client purchased the property for $20,000 and the recipient subsequently sells it for $100,000, the recipient would pay capital gains tax on $80,000 ($100,000 minus $20,000). If the recipient is subject to a capital gains rate of 15%, then he or she will have to pay $12,000 in capital gains tax. Note, the capital gains rate may be higher depending on how long the asset is held and if the seller’s modified adjusted gross income is over $200,000 (single filers) or $250,000 (joint filers).
Non-taxable Estate, Transfer At Death. In contrast, if the client transferred the property to the recipient at the client’s death, then, (i) no Federal estate taxes would be payable, and (ii) the recipient would receive a step up in tax basis equal to the value of the property at the date of the client’s death. So, if the property was valued at $100,000 on the client’s death, and the recipient sold it for $100,000 shortly thereafter, the recipient would pay no capital gains tax on the sale.
So, for non-taxable estates, if property has appreciated, or is likely to appreciate prior to the client’s death, then it may be preferable to transfer the property at death rather than by gift during life so the recipient is not subject to capital gains tax. However, other factors may still suggest that a gift today is the preferable approach. Examples include: if the recipient is unlikely to sell the property (e.g., it will be held in the family), if the client is expected to live a long time and the recipient needs the property now, and if the client may have a taxable estate (see below).
Taxable Estate. If the client’s estate is, or may be subject to Federal estate tax on his or her death, then the client needs to balance the Federal estate tax costs he or she would bear against the capital gains costs the recipient could bear.
Taxable Estate, Transfer By Gift. Recall that, no Federal estate tax is payable or reportable for gifts of less than the annual exclusion amount but that that gifts in excess of this amount require filing a Federal gift tax return. Federal gift tax is not payable until the cumulative sum of all gifts given by the client during his or her life exceed the Federal exemption amount. Once the Federal exemption is exceeded, Federal gift tax of up to 40% (as of 2013) is payable on the gift valued as of the date of the gift. In addition, the recipient of the property will take the property at the donor’s tax basis so, if he or she sells it, then capital gains tax must be paid on the difference between the sales proceeds and the donor’s tax basis. So using the example above, but assuming the client is subject to Federal estate tax on the gift, a gift of $100,000 would result in the client paying $34,400 in Federal estate tax, i.e., ($100,000 minus the $14,000 annual exclusion amount) multiplied by 40% and the recipient would have to pay $12,000 in capital gains tax (assuming a 15% capital gains tax rate).
Taxable Estate, Transfer At Death. In contrast, if the client transferred the property to the recipient at the client’s death, the recipient would receive a step-up basis in the property, but the client would still be subject to Federal estate tax and the more the property has appreciated, the higher the tax will be. Thus, clients with property that may appreciate are often incentivized by the tax code to gift it now rather than waiting to transfer it on their death. Notwithstanding the tax benefit of transferring property by gift, other factors may bear on a clients decision including uncertainty as to whether the client will have enough assets to live comfortably for the rest of his or her life and the desirability of retaining use of the property.
Note also that even though the gift and Federal estate tax rates are the same, paying gift tax today reduces the total taxes payable to the Government. This is because estate tax is calculated on the whole of the taxable portion of the estate- including the amount that will be paid to the Federal Government as estate tax. In contrast gift tax paid prior to death reduces the taxable estate. For example, if the client gave his child a gift of $1 million, then the cost of the gift, at a 40% estate tax rate, would be $1.4 million. If, in contrast, he had $1.4 million to give to his son at death, then the estate tax on that $1.4 million would be $560,000, leaving a gift of only $840,000 to his son (net of taxes) rather than the full $ 1 million.
Finally, certain gifts are exempt from Federal estate tax including gifts to spouses and payment of medical and educational expenses directly to institutions.
Summary. The decision as to whether to gift assets now or at death should be guided by the objectives of the client and not be driven by tax concerns. That said, taxes can impact the decision and should be considered.
Mathieu, Ranum & Allaire, PLLC is a boutique law firm with offices in Boise and Sun Valley, Idaho focusing exclusively in the areas of estate and trust planning, probate and trust administration, asset protection, business law and charitable organization laws. We represent individuals, families, trustees, heirs and beneficiaries, entrepreneurs and closely held businesses, tax-exempt organizations, and family offices, as well as professionals and business owners potentially exposed to future creditor claims.