2009 Year-End Estate and Gift Tax Planning
It appears certain that the fedral estate tax will be retained. Although there are various estimates as to what level of estate tax might be retained, there are many future political and economic occurrences yet to unfold, that could ultimately affect the level of federal estate tax that we are left with. This being the case, there are several relatively simple planning possibilities that can be implemented before the end of the year that will serve to reduce potential estate taxes.
Use of Gift Tax Exemptions to Reduce Estate and Gift Tax
The 2009 fedral estate tax exemptim is sheduled to be 3.5 million, although this amount will be reduced to $1.0 million in 2011 unless Congress decides to increase it. An important method of ensuring that your estate will not be subject to estate tax is to make sufficient gifts during your lifetime so that at your death your estate is smaller than the then-current exemption amount.
Your lifetime gifts are, however, subject to a gift tax that is imposed at the same rate as the estate tax. This "unified" system is intended to eliminate any tax advantage to making gifts. But certain types of lifetime transfers are not subject to gift tax and the end of the year is a good time to make such tax-free gifts.
The most commonly used method for tax-free giving is the annual gift tax exclusion, which allows you to make a gift of up to $13,000 on an annual basis to each donee with no gift tax. There is no limit on the number of donees to whom you can make such gifts — if you make gifts to 10 donees, you can exclude up to $130,000 of these gifts from tax. In addition, if you are married you can double the amount of the exclusion to $26,000 per donee, because you and your spouse can combine your exemptions in a single gift from either of you.
Your annual gift tax exclusion expires at the end of each year, so the year-end is the appropriate time to take advantage of it. If you want to make a gift that exceeds the amount of the exclusion, you can effectively double the exclusion by making one gift in December and the second in January. For example, if you are married, you can make a total tax-free gift of $52,000 to any individual by making a gift of $26,000 in December and another $26,000 in January.
As noted above, the annual exclusion is applied on a per-donee basis. As a result, you can leverage the exclusion by making gifts to multiple members of the same family. For example, you could make $13,000 gifts to each of your son, his wife and his daughter, for a total of $39,000 in tax-free gifts. This amount can be doubled to $78,000 if your spouse joins in the gifts.
In addition to the annual gift tax exclusion, you are also allowed to make tax-free tuition payments for any individual. There is no limit on the amount that can be excluded, except that the payment must be to a tax-exempt school and must be for the purpose of "education or training." Because there is no limit on the amount of the gift, the timing is less important than it is with the annual exclusion. Nevertheless, if you have the choice of making either a tuition payment or an annual exclusion gift for a particular beneficiary, it will usually be better to make the tuition payment, because that will leave you the option of making an annual exclusion gift later in the year.
Section 529 College Savings Plans
Contributions to a section 529 college savings plan do not qualify for the exclusion for tuition payments, but can take advantage of the $13,000 annual gift tax exclusion.
Distributions from a 529 plan can be used for a wide range of educational expenses, including tuition, fees, books, supplies, and room and board. An added advantage of a gift to a 529 plan is that the income earned on the contribution is tax-free, as long as the contribution is eventually used for educational purposes. And because you can name yourself as the custodian of the account, you ensure that your beneficiary uses the account for educational purposes.
A special rule allows you to use up to five annual gift tax exclusions when funding a 529 college savings plan. You can fund a savings plan with up to $65,000 and then file an election with the IRS to spread this gift over five years for gift tax purposes. By using five $13,000 annual exclusions, the entire gift is tax-free.
The payment of a beneficiary's medical expenses is also excluded from the gift tax, with no limitation on the amount excluded. To qualify for this exclusion, the payment must be made directly to the provider, and it must be for medical expenses that would qualify for an income tax deduction. You cannot claim an income tax deduction for the payment unless the payment is made for your spouse or dependent.
The exclusion for medical payments includes the payment of medical insurance. If you have a child or grandchild who is paying for his or her own insurance, payment of their insurance premiums is an efficient means of making a tax-free gift that does not consume the $12,000 annual exclusion.
Despite the tax savings, you may be uneasy about making outright gifts to your children and grandchildren, due to the loss of control over how they use the gift. This concern can be addressed by making the gifts in trust, which will allow you to determine when they receive the money and how it is to be used.
There are special requirements for ensuring that a gift in trust qualifies for the $13,000 annual exclusion. Usually, the trust is drafted to provide the beneficiary with sufficient control over the gift that it is considered a "present" interest rather than a "future" interest. Although this presents a risk of the beneficiary withdrawing the gift from the trust, the potential loss of your making any further gifts to the trust is usually sufficient to prevent this. If you are interested in making a gift in trust, we will be glad to explain how this is done.
The year-end is a good time to review your charitable giving to ensure that it is being done in the most tax-efficient manner. Charitable giving is a form of estate planning, because anything given to charity will never be subject to estate or gift tax. If you are planning to make a large gift, we should review its impact on your over-all tax liability and whether it may make sense to defer all or a portion of the gift to 2009. If the gift is of property that will require an appraisal (usually gifts of property with a value in excess of $5,000, other then publicly traded stock), we should start the process as soon as possible so that the appraisal is available before year-end.
In conclusion, we hope that the information in this letter is useful in your year-end gift planning. If you wish to discuss any of the planning techniques that we have described, please feel free to call.