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For larger estates, a basic estate plan can reduce but not eliminate estate taxes. For example, in 2020 a couple with an estate of $30,000,000 can eliminate taxes on $23,160,000 (two times the 2020 estate tax exemption of $11,580,000) by use of a by-pass (“credit shelter”) trust or making a portability election when the first spouse dies. However, the remaining $6,840,000 will be subject to estate tax of 40% unless further action is taken.

Annual Gifting

The simplest and often most effective, mechanism for further reducing estate taxes is through lifetime gifts. Each year, an individual can gift up to the annual gift tax exclusion amount ($15,000 in 2020) to another individual without any income, gift or estate tax consequences. The only requirement is that the gift must be of a present interest, in other words, a gift of an asset one currently owns, rather than the right to receive an asset in the future.

If an individual (the donor) gifts more than the annual gift tax exclusion amount in any one year to another individual, then the amount in excess of the exclusion amount reduces the donor’s lifetime gift and estate tax exemption amount ($11,580,000 in 2020). Although no tax must be paid, a gift tax return must be filed. If the donor has depleted his or her lifetime gift and estate tax exemption amount, then the excess amount over the annual gift tax exclusion is subject to gift tax.

A couple, by joining together in a gift, can gift $30,000 (in 2020) annually to any one individual without any tax consequences (as long as the gift is of a present interest.) If a couple has assets in excess of both their needs and the current gift and estate tax credit, then they may be able to substantially reduce their taxable estate by making annual gifts during their lifetimes to their heirs. For example, a couple with three children could gift $90,000 annually ($30,000 per child in 2020) without any tax consequences.

In addition, such a couple might also make gifts to grandchildren. For example, a common gifting strategy is to make gifts to an UTMA account (Uniform Transfers to Minors Act account) for the benefit of a grandchild. An UTMA account is controlled by an adult custodian (normally the parent) until the child reaches age 18 or 21. Often, the assets of UTMA accounts are used to pay for college education.

Another option is to make gifts to a 529 college savings plan.  A 529 plan is an investment account that offers tax free earnings growth and tax free withdrawals when the funds are used to pay for qualified education expenses.

In 2020, an individual can give an annual gift of $15,000 to a 529 plan or for a married couple, this amount doubles.  There is also a five-year gift option, in which you can donate a lump sum gift spread over five years tax free.  In that case, an individual can contribute $75,000 tax free to a 529 Savings Plan or a couple can donate $150,000.  If you give a lump sum contribution, you cannot gift any additional money to this person over the next five years and a gift tax return will be required disclosing the gift.

Using the Gift and Estate Tax Credit During Life

In some instances, an individual with excess assets may desire to use up their gift and estate tax credit during their lifetime by immediately making annual gifts with values in excess of the annual gift tax exclusion. For example, an individual could gift to his or her children in a single year an amount equal to the annual gift tax exclusion plus the gift and estate tax exemption. This amount will not result in any taxation but will completely use up the individual’s gift and estate tax exemption. When the individual dies, all remaining assets in his or her estate will be subject to estate tax (ignoring any potential increase in the lifetime estate exemption amount in future years).

Gifting Appreciating Assets

How does an individual decide whether to use up the estate tax credit during his or her lifetime or only at his or her death? The answer often depends on whether the individual holds assets which he or she expects to appreciate substantially before his or her death. If an asset is expected to appreciate rapidly, it is often better to gift it now at a low value even if the gift uses up the estate tax credit.

Indeed, the idea of gifting currently those assets which are expected to appreciate most rapidly in the future is a significant consideration in most gifting strategies, including annual gifts which make use of the annual gift tax exclusion. If a major purpose of your estate plan is to reduce your taxable estate at the time of your death, then you want to make gifts which allow you to gift the greatest amount of potential future appreciation.

For example, assume you hold a money market fund worth $10,000 which yields 5% annually but does not appreciate, and a stock worth $10,000 with no dividend yield but which is expected to appreciate 10% each year. You wish to make a $10,000 gift to a child. Should you gift the stock or the money market fund? If you gift the money market fund and then die ten years later, the stock will have grown to $25,937. All of that value will be included in your estate. If you gift the stock instead of the money market fund and then die ten years later, the money market fund plus all accrued interest will have grown to approximately $16,289. All of that value will be included in your estate. This means that by gifting the stock instead of the money market fund, the value of your estate will be $9,648 less. That incremental value will belong to your child without being subject to estate taxes.

Of course, this strategy assumes that you can reasonably predict which assets will appreciate most rapidly in the years ahead. In many cases you can make reasonable predictions. For example, over long time periods stocks in general can be expected to appreciate more rapidly than bonds. In other cases, however, it is not so easy. Even though stocks in general may rise, the stock in a particular company may fall. Also, a family business that has grown rapidly in the past may suddenly run into business setbacks in the future and lose value. Sometimes, the vagaries of the market can thwart the best designed gifting strategies.

Gifts and Income Taxes

Another important consideration in developing gifting strategies involves income taxes (as distinct from estate taxes.) At your death, all of your assets receive a step up in their tax basis to their value as of the date of your death for purposes of determining future capital gains. For example, assume you own $10,000 of XYZ stock for which you paid $1,000. If you sell the stock you will realize $9,000 of capital gains income subject to capital gains tax. However, if you die holding the stock, and your heirs subsequently sell it for $10,000, then they will realize no capital gains income on the sale, since they will be treated as having paid $10,000 for the stock.

On the other hand, if you gift the stock to your heirs during your lifetime, then for purposes of determining gain they take over your tax basis in the stock. This means that if they sell the stock for $10,000 after having received it from you as a lifetime gift, then they will realize $9,000 in capital gains income subject to capital gains tax.

This means that for people with short life expectancies and highly appreciated assets, they may decide not to gift the highly appreciated assets. Rather, they will retain those assets in their estates in order to minimize income taxes, and instead, gift other assets with no or low unrealized capital gains.

Alternatively, someone with a relatively long life expectancy and highly appreciated assets may decide to gift the highly appreciated assets to heirs who currently are in a significantly lower tax bracket; for example, grandchildren without significant income. The grandchildren can then sell the assets and may pay no or only a small amount of capital gains tax.

These examples illustrate that the interplay of both estate and income taxes in gifting strategies can become relatively complex. The important thing is not to know all of the technical intricacies of the tax laws, but rather, to be aware of basic tax issues so you can make sure they are being considered in your gifting strategies.

We at Cerity Partners are ready to work with clients, their attorneys, and tax professionals on the merits and specifics of these and other investment and financial planning options. For additional information on this or related topics, or to learn more about the investment management and financial planning services offered by Cerity Partners, please visit our website at www.ceritypartners.com.


Cerity Partners LLC (“Cerity Partners” is an SEC-registered investment adviser with offices in California, Colorado, Illinois, Massachusetts, Michigan, New York, Ohio and Texas. Registration of an Investment Advisor does not imply any level of skill or training. The foregoing is limited to general information about Cerity Partners’ services, which may not be suitable for everyone. You should not construe the information contained herein as personalized investment, tax, or legal advice. There is no guarantee that the views and opinions expressed in this brochure will come to pass. Before making any decision or taking any action that may affect your finances or your company’s finances, you should consult a qualified professional adviser. The information presented is subject to change without notice and is deemed reliable but is not guaranteed. For information pertaining to the registration status of Cerity Partners, please contact us or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov). For additional information about Cerity Partners, including fees and services, send for our disclosure statement as set forth on Form CRS and ADV Part 2 using the contact information herein. Please read the disclosure statement carefully before you invest or send money.


Meet the Author

Judith Gordon

Principal

Judy is a Principal based in the Silicon Valley office. She provides consulting advice for private clients and advisors on estate planning, wealth-transfer strategies, d trust and estate administration, and charitable planning. With her extensive law background, Judy works collaboratively with clients and their tax advisors and estate planning attorneys to ensure that their strategies are consistent with their overall financial and estate plans and to manage, preserve, and grow their wealth for their family and philanthropic goals.

Prior to joining Cerity Partners, Judy worked as an Estate Planning Advisor at B|O|S and served as a member of the Financial Planning Team. In this role, Judy helped clients navigate significant life changes, minimize their tax burden, and identify goals and strategies for legacy planning. Prior to joining B|O|S, she enjoyed a 35-year legal career in sophisticated gift and  estate tax planning, charitable planning, and probate and trust administration.

Judy earned her Bachelor of Arts in Psychology from the University of Florida and her Juris Doctor degree from Georgetown University. She also received her Master of Laws from New York University.

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