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1 Suitability of gifting as a planning strategy The following are the requirements for a transfer to be viewed as a valid gift: A The donor must be capable of transferring property B The donee must be capable of receiving and possessing the property
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Topic 84: Gifting Strategies - 291 C There must be delivery to, and some form of acceptance by, the donee or the donee s agent D The donor must not maintain any interest in the property Techniques for gift-giving When designing a gifting program, a planner should consider: A Giving assets with high rates of return, as opposed to assets with lower rates This strategy can help avoid a buildup of revenue in the estate that would be taxed at the donor s tax rate B Giving income-producing property to eliminate the income tax payable by the donor on the property For example, if the donor is in the highest tax bracket and the donee is in a low tax bracket, substantial tax savings within a family unit can result if the income-producing property is given to the donee C Giving growth assets rather than stagnant assets This plan will prevent the post-gift appreciation from being taxed in the donor s gross estate D Giving assets with a high basis rather than a low basis If an asset with a low basis is held until death, the receiver of the asset is subject to a step-up in basis equal to the fair market value at the time of death If the asset is gifted, the basis remains the same for the donor and the donee E Selling assets whose value is less than their basis Selling these assets results in a loss to the owner, which may possibly be deducted from the donor s income taxes F Avoid gifting installment obligations The donor will have to recognize the entire untaxed proceeds at the time of transfer G Before gifting stock in an S Corporation to a trust, make sure the gift will not cause the loss of S Corporation status Appropriate gift property A Income-producing property, such as rental property B Property that is likely to grow substantially in value, such as life insurance, common stock, antiques and art, or real estate C Property owned by the donor in a state other than his or her own state of residence Such a gift will avoid ancillary probate at the time of the donor s death D Property, which has already appreciated, if the donor is contemplating selling it and the donee is in a lower tax bracket than the donor E It is generally not a good idea to give away property that would result in a loss if sold, inasmuch as the donee cannot use the donor s loss The appropriate strategy would be for the donor to sell the property, take the loss, and give away the cash proceeds Strategies for closely held business owners Stock in a closely held corporation can often be an ideal asset for gift purposes, but care must be taken so that not too much stock is given away If an estate retains too little closely held stock, it may fail the percentage tests that qualify it for privileged treatment A minimum of 35 percent of the value of the adjusted gross estate (AGE) must consist of closely held stock to qualify for the Section 303 redemption or for the Section 6166 installment payment of estate taxes Gifts of present and future interest A The gift tax exclusion is available only for gifts of present interest; the exclusion does not apply to gifts of future interest B For a gift to be considered a gift of present interest, the donee must have the immediate right to use, possess, or enjoy the property A gift will be considered one of future interest if the right to use, possess, or enjoy the property is delayed C In making a gift to a trust, the gift will be considered to be of present interest only if the bene ciary has the right to demand immediate custody of the property transferred
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292 - Estate Planning D The most common types of future interests (1) Reversion A future interest in property that is retained by the transferor after he or she transfers interest in property Example: Steve transfers property in trust to Sarah for her life The document does not explain what will happen to the property after Sarah s death Steve has retained a reversionary interest The trust property will belong to Steve when Sarah dies If Steve dies before Sarah, the property will belong to his estate (2) Remainders The right to use, possess, and enjoy property after all prior owners interests end Example: A businessperson gives money to a trust, which states that the income is to be paid currently to his or her child and upon termination of the trust the principal is to be transferred to his or her grandchildren The value of the remainder interest to the grandchildren would not be eligible for the annual gift tax exclusion (3) The income bene ciaries receive a life estate or estate for years in the trust income (present value interest); remaindermen (bene ciary of trust corpus at termination of all other interests) receive the remainder at termination of the income interests (future value interest) E Statutory exceptions to present interest requirement (1) Minor s trust or Section 2503(c) trust (a) Considered a present interest gift and thus will qualify for the annual exclusion (b) The property passes to the minor on attaining the age of 21 years In the event of the minor s death before attaining age 21, it will be payable to the estate of the minor or as he or she may appoint under a general power of appointment (2) Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) (a) Considered a present interest gift and thus will qualify for the annual exclusion (b) Each state has one or the other, UTMA being the more modern version of UGMA These are statutory creations, requiring a custodial institution (usually a bank, securities institution, etc) to hold the funds for the minor and a custodian to be the person responsible for the account (c) The funds stay under the domain of the custodian until the bene ciary is 21 (by statute in almost all states, although at least one state allows an 18-year-old to take control of his or her account) At age 21, the bene ciary has full rights and control over the balance of the funds (d) If the donor dies while being the custodian, the value is brought back into the donor s estate (e) Established for education purposes (3) Section 529 plans (a) The donor can donate this year s and the next four years annual exclusion at one time and still qualify for annual exclusion (b) If the donor dies before the completion of the years for which the gift was made, the portion of the original transfer attributable to years in which the donor did not survive will be included in the donor s taxable estate (c) The donor may remain in control without inclusion in estate The donor may change bene ciaries within a range of related parties if the original bene ciary does not need the money for college
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Topic 84: Gifting Strategies - 293 F Common law exemption Crummey power (1) For use in a trust that does not satisfy the requirements of Section 2503(c) (2) Gifts placed in an irrevocable trust are a gift of a future interest, but by placing a lapsing power (Crummey power) to withdraw, a future interest is converted to a present interest A Crummey power makes a transfer to a trust a gift of a present interest 6 Tax implications A Income (1) The main reason for making a gift of income-producing property is to eliminate the income tax payable by the donor on the property For example, the tax savings are obvious when the donor is in a high income tax bracket and the donee is in a low income tax bracket (2) The age of the receiver matters If the donee happens to be a child under the age of 14, the kiddie tax will be imposed on the net unearned income of the child B Gift (1) A planned gift program can minimize a donor s overall estate, minimize gift taxes, and maximize the overall after-tax income available to a family unit during the donor s lifetime (2) Valuation of gift (a) The value of a gift is its fair market value on the date of the gift (b) Any consideration received by the donor reduces the value of the gift (3) Transfers made within three years (a) Any gift tax paid on gifts within three years of death must be added to the gross estate This is called the gross-up approach, which prevents the amount of the gift tax from escaping the estate tax (b) Gifts made within three years of death are not included in the gross estate of the donor They are treated in the same way as any other post-1976 taxable gift (ie, added to taxable estate) Exceptions to this general rule include property under Section 2036, transfers with life estate; Section 2037, transfers taking effect at death; Section 2038, revocable transfers; and Section 2042, proceeds of life insurance (4) Creation of joint ownership (see Topic 87) (a) When property is purchased with the funds of one person and titled jointly, a completed gift is made (b) The most notable exceptions to this are titling of property jointly between husband and wife and titling of joint bank accounts and United States Savings Bonds (c) In the case of a joint bank account or United States Savings Bond, a completed gift is not made until the noncontributing joint owner draws upon the bank account or surrenders part of the bond for cash (5) Exercise of a general power of appointment (see also, Topic 89) (a) A general power of appointment is subject to gift tax (versus a limited or special power of appointment) (b) A general power of appointment is the power of the holder to appoint to the holder, the holder s estate, the holder s creditors, or the creditors of the holder s estate (c) This section must be kept in mind when creating trusts with Crummey powers, as Crummey powers are general powers of appointment
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294 - Estate Planning (d) Events that trigger gift tax to holder of power of appointment i Section 2514 Provides that the exercise or release of a general power of appointment shall be deemed a transfer of property by the individual possessing such power ii Section 2514(e) Treats the lapse of a power as a release only to the extent that the property, which could have been appointed by exercise of such lapsed power, exceeds in value the greater of $5,000 or 5 percent of assets (6) Transfer of property cost basis (a) Basic rule: Recipient (aka donee or transferee) takes donor s basis i Exception 1: When the transferred property is included in the donor s taxable estate at death, by being subject to Section 2036, 2037, or 2038, the inclusion gives the recipient a date-of-death fair market value as the basis ii Exception 2: When property is gifted that has a fair market value less than the donor s adjusted cost basis, the recipient s basis for future loss is the fair market value as of the date of the transfer and the recipient s basis for gain is the donor s original adjusted cost basis (b) Example: Bob has 100 shares of yinghighcom for which he paid $100 each Today they are worth $5 each Bob gives the shares to his daughter Samantha Samantha now has two bases, one for future loss and one for future gain Should she sell the stock for $4 each, she will have a loss (for purposes of offsetting other capital gains) of $1 per share The possible tax bene t from the loss from $100 to $5 is forever gone However, should the stock go up to $50, Samantha s basis is $100 (Bob s original adjusted basis), and thus there would be no loss or gain on the sale Note that had Bob sold the stock for $50, he would have been able to claim a $50 per share loss to offset other gains Samantha cannot take advantage of this loss If the stock goes up to $150, Samantha s gain will be $50, the same as Bob would have had C Estate (1) The uni ed credit is a dollar-for-dollar reduction of any gift or estate tax due Estate and gift taxes will no longer be uni ed, in that the exclusion amounts for each will be different beginning in 2004 The gift tax uni ed credit is $345,800 in 2002 to 2009, which is equivalent to an exemption of $1 million (2) Example: Ben and his wife, Martha, make a $1 million present interest gift in 2003 to their only son The computation for each spouse is as follows: Gift (split) Annual exclusion Net gift Tax on net gift Uni ed credit Net tax due $500,000 $10,000 $490,000 $152,400 $345,800 $0
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To the extent that the credit is used during lifetime, it will have the effect of reducing the credit available against the estate tax For estate tax purposes, there will be only a $193,400 credit left for each spouse (in 2003) Additional credits will be available as the uni ed credit increases in subsequent years
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Topic 85: Gift Taxation and Compliance - 295 (3) Gift tax rates are cumulative As a donor makes gifts that are subject to gift tax over the years, the previous years gifts are added together with gifts made in the current year in order to determine the gift tax bracket for current gifts
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