My family has had the pleasure of welcoming the next generation. The joy they bring to the family is immeasurable. And my generous parents, like countless other clients say, “I want to see my children and grandchildren enjoy the fruits of our labors. What should we do?” The key is to gift strategically.
Rumors abound whether Trump will effectively restructure the estate tax and allow individuals to pass an unlimited amount at death. However, if such legislation passes, it will likely have a sunset provision so we may very well see the return of the estate tax. Thus, in uncertain times, arguably the need for planning plays an even more vital role.
The current estate tax exemption is $5.49 million per person at the federal level, but exemptions vary from state to state. Depending on the client’s state of residency, the estate tax may be as high as 50 percent. So, for clients with taxable gross estates, gifting plays a critical role in wealth transfer. Even for those with more modest means, it is important to incorporate strategic adjustments when gifting to the next generation.
Gifts – use ‘em or lose ‘em!
On an annual basis the IRS allows you to gift a certain amount to any beneficiary, also known as an "annual exclusion gift.” In 2017, the annual gift exclusion is $14,000 per person (or $28,000 for a married couple). Thus, grandma and grandpa could gift $28,000 to each grandchild free of gift taxes. These annual exclusion gifts are in addition to the $5.49 million lifetime gift exemption. Unfortunately, however, if a gift is not made in a particular calendar year, it cannot be rolled over to the next year. Thus, use it or lose it!
Boo-Boos and ABC’s
Under IRC Section 2503(e), tuition payments made directly to an educational organization (for anything from private nursery schools to grad school) or healthcare provider are not treated as taxable gifts (they are not considered part of the donor's $14,000 annual gift exclusion or $5.49 million lifetime exclusion). Most important, the payments cannot be made to reimburse someone for the expenses; payments must be made directly to the provider. To facilitate ease of payment for education and medical bills, many families implement “Family Credit Cards” to be used for qualified expenses. Grandma and grandpa can then use their bonus airline mileage (or other benefits) to travel with their grandchildren.
529 Plans
With college costs continuing to skyrocket, many are eager to help put money away for the lil’ peeps – and they recognize the importance of starting early. Funding a child’s education is likely the best gift one can give. A 529 Plan is a tax-advantaged investment vehicle designed to encourage saving for future educational expenses of a designated beneficiary. Contributions are considered taxable gifts and must be taken into consideration in light of your overall gifting strategy. Most attractive, the capital appreciation in 529 Plans is tax-deferred provided that distributions are made for qualified educational expenses. In addition, some states provide state income tax deductions for a portion of the contribution. Contributions for five years can be made at one time and beneficiaries can be changed among family members.
UTMA Accounts
Uniform Transfer to Minor Accounts (UTMA), or Guardian Accounts can be somewhat dangerous as assets can quickly grow over time. In many states, when a beneficiary reaches age 18, she can go to the bank and withdraw all of the funds. I have witnessed tragic situations where families put money into a UTMA account for many years and later discover a child with special needs would not qualify for governmental assistance. When the UTMA accounts get too large, one option is to transfer the property to a 2503(c) trust, which allows the assets to be held in trust for a minor beneficiary provided that the beneficiary has a 30- to 60-day window to withdraw all of the principal and income upon reaching the age of 21. Another option is to transfer the funds to a limited liability company managed by a parent. Keep in mind that once the funds are gifted to a minor outright, they are included in her taxable gross estate. With proper planning, consider trusts over UTMA accounts for the estate tax and asset protection benefits.
Intentionally Defective Grantor Trusts
If clients desire to gift other assets, such as interests in a closely held family business, intentionally defective grantor trusts (IDGT) are recommended. These irrevocable trusts are defective for income tax purposes whereby all of the tax attributes flow back to the Grantor who created the trust. When grandpa is the Grantor who created the trust, the payment of tax liabilities are not considered gifts and additional wealth is transferred. Language can be added to the trust allowing the trustee the ability to distribute funds to the Grantor to cover tax liabilities if there is an issue with grandpa paying the tax liability in a given year. The trust is asset protected from creditors and if properly structured can be excluded from the beneficiary’s taxable gross estate, allowing the funds to pass estate tax free from generation to generation.
Depending on your particular goals, there are a myriad of creative estate planning tools available that can be customized to meet your specific needs and facilitate the transfer of wealth from generation to generation.
For further information on this topic, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
