Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

AN EASY ESTATE PLAN - GIVE IT ALL AWAY
(9/15/02)

In a recent column, I alluded to the fact that you can give $11,000 per year to as many people as you want without incurring any estate or gift tax. This simple statement generated a number of inquiries, so I thought I would expand on it somewhat.

Many wealthy people are missing out on the opportunity to reduce their taxable estate by making regular "annual exclusion" gifts. Some people confuse these annual gifts with the "unified credit" which allows you to pass $1 million to your heirs free of estate or gift tax. They think the annual gift has to be subtracted from this total. It doesn't. Others are under the mistaken assumption that they will be subject to some kind of special gift tax. They won't. Finally, some believe that the recipients of their largesse will have to report these gifts on their income tax returns and pay taxes on them. This is equally wrong. The bottom line is that you can give away $11,000 per year to anyone you care to without anyone incurring any taxes at all. If you are married and your spouse joins in the gifts with you, you can give away $22,000 per year to each person free of tax.

Why Don't More People Take Advantage of This Law?

This is a good question. According to one study I read, nearly two-thirds of elderly families who are facing estate taxes at their death still aren't taking advantage of these gifts to reduce or eliminate taxes at their death.

One reason is that many older people fear they will outlive their savings and simply refuse to give away any of their accumulated wealth. Recently, I spoke with a client in her mid-seventies who is worth over $2 million. Her husband and her child are deceased. She plans to leave a large portion of her estate to her church and charitable institutions, but the rest will be divided among her surviving nieces, nephews, and cousins. When I suggested she could increase the amount going to these relatives by making annual gifts to them and reduce the total estate tax at her death, she was aghast. Her answer: "I can't give anything away. I might need it to live on."

She then disclosed that she was going to receive a substantial inheritance from another family member. I suggested she disclaim this gift so it would pass to the residual beneficiaries and not be taxed again as part of her estate. Her answer was the same. And her response was not an unusual one.

Another common them I regularly hear from clients is, "I can't give them anything - they'll just blow it." An obvious answer to this is would your rather they blow $11,000 while you are still around to see how they handle the money, or do you just want o leave them the whole kit and kaboodle after you are gone and let them blow it all at one time?

One approach I recommend, with varying degrees of success, is to go ahead and make a small gift of $11,000 or less now and see what happens. If the beneficiary uses the money wisely, then you can make a gift again next year. If the beneficiary blows it, you can consider other alternatives, such as establishing a spendthrift trust with strict controls and designating a third party trustee to monitor how the money is used. This way, you can make annual exclusion gifts to the Trust, which will remove the money from your taxable estate, while still keeping strings on it to make sure it isn't wasted.

The most common answer I encounter, however, is that the client didn't know this rule existed. Once I explain how it works and that the gift is completely tax-free, quite a few clients set up a regular annual gifting program.

2001 Rule Change

Several times when I have explained this rule to a client, he or she has interjected that the gift is limited to $10,000, not $11,000. This is because the client wasn't aware of last year's rule change. While the limit stayed at $10,000 for many years, it was adjusted to $11,000 in 2002 to reflect the increased cost of living.

There is yet another common misperception regarding these annual exclusion gifts. More than one client has asked me how to report the gift on his federal income tax return. The simple answer is that you don't report it anywhere. I know it is hard to believe the government is so lenient and easy to work with, but in this instance, it is. The gift doesn't need to be reported to anyone and no tax needs to be paid.

Finally, some clients have asked me how to deduct these annual exclusion gifts on their federal income tax returns. The answer there is just as easy - can't. The only time a gift is reported on your income tax return is if it is to a qualified charitable organization and then only if you itemize deductions. Otherwise, the gift has no tax consequences.

Do I Ever Need to File a Tax Return?

There is one instance in which you would have to file a tax return. That is if you give more than $11,000 to someone in a given year. Let's say you give your grandson $20,000 to buy a new car. You would have to file a gift tax return showing the entire $20,000, deduct the $11,000 annual exclusion gift, and report a taxable gift of $9,000. So long as you haven't used up your one time $1 million lifetime exclusion, this amount will just reduce the remaining exclusion and no tax will be due at this time.

If you have already made taxable gifts equal to or in excess of the lifetime exclusion of $1 million, some would be due on this $9,000 gift.

Are There Any Other Gifts I Can Make?

As a matter of fact, there are. For example, if you pay someone's medical or education expenses, they don't count against the $11,000 per year limit. The key here is to make these payments directly to the hospital or university, not to your intended beneficiary. There are two good reasons for this. First, if you give it to a niece or nephew, you don't have any assurance that the money will be used for its intended purpose. Second and most important, the law says you have to make these payments directly to the institution.

This has been a short overview of some fairly complicated gifting rules. If you have a taxable estate and feel you might benefit by making current gifts to your beneficiaries, you should consult with an estate planning attorney who can walk you through the process.

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