Category Archives: Gift

Gift Taxes in a Nutshell

Title Deed with keys

When does my generosity, or my desire to give gifts during my life, trigger the application of federal tax laws regarding gift taxes? Consider the following scenarios:

  • Declan wants his daughter Fiona to receive his residence at his death. He and his late wife purchased the property for $30,000 in the early 1950s. He signs and records a deed in 2015 that conveys the property to himself and Fiona as joint tenants. As of the date of the conveyance, the property is worth $300,000. He continues to reside there and to pay all property taxes, insurance and maintenance.
  • Teresa opens a bank account in 2014 and transfers $500,000 to the account. She names herself and her son Juan as joint tenants with right of survivorship at the time she opens the account. Under the account terms, both Teresa and Juan have the right to withdraw the entire amount of the bank account at any time. Juan does not withdraw any funds from the account the first year. He withdraws $40,000 in 2015 to pay his college tuition.

Has Declan or Teresa made a taxable gift? If so, when was the gift made and for how much? Could either of them have achieved the same result but avoided the gift tax rules?

The gift tax is a tax imposed on certain gifts made during life. Not every gift is taxable. The IRS allows a generous annual exemption, currently $14,000, per donee. This means you may give up to $14,000 each year to an unlimited number of recipients without having to file a gift tax return. (The amount was established at $10,000 and is increased periodically for inflation; it has been $14,000 since 2013). Also, you may give unlimited gifts to your spouse (if a U.S. citizen) or to §501(c)(3) charities without incurring a tax. You may also pay tuition for education and medical bills on another’s behalf without tax consequence if you pay such amounts directly to the educational institution or health care provider.

Even if you make gifts that are taxable, Congress has provided for a unified credit that allows you to make otherwise taxable gifts throughout life and at death up to a sum total of $5,450,000 (for those who die in 2016) without paying a gift or estate tax. The credit is “unified” in the sense that it is applied both to gifts made during your life time and to gifts made at death from your trust or estate, up to the maximum credit. Each year the unified credit is adjusted upward for inflation. Gifts made above that amount are taxed at a whopping 40%.

Returning to our examples, the fact is that both Declan and Teresa have made taxable gifts that require a gift tax return to be prepared and filed with the IRS; and both could have avoided this result with some good legal advice and planning.

Declan has made a taxable gift of one half the value of the real property, or $150,000, to Fiona. He can count the first $14,000 toward the annual exclusion, but he still must file a gift tax return for the remaining $136,000. Even worse, since the transfer was made during his life time, if and when Fiona sells the house after his death she will have to pay a capital gains tax on the increase in value from the $30,000 purchase price. Had Declan conveyed the property to her at his death, she would have received a step up in basis, meaning the base price for considering a capital gains tax would have been the value at his date of death, rather than the value of the original purchase in the 1950s. This would have been a huge tax savings to Fiona. It would also have eliminated the requirement of the gift tax return.

Teresa makes a gift of $40,000 to Juan in 2015 when he withdraws that amount from the account. She must file a gift tax return for the gift, after offsetting the amount of the annual exclusion. The joint bank account is treated differently than a joint tenancy in real property; until and unless Juan withdraws money from the account over and above any contribution he may have made to the account, there is no gift because Teresa can still withdraw the whole amount. Here, Teresa could have paid Juan’s school directly for the tuition without any gift tax consequence.

Note that for both Declan and Teresa, assuming no previous gifts have been made, no actual tax is due because the unified credit will cover these relatively modest amounts; but the hassle and cost of preparing the gift tax return could have been avoided. Moreover, if either has an estate that will exceed the unified credit at the time of death, these gifts will have negative consequences for their estates.

If you are thinking of making a large gift, it is well worth consulting with your accountant or estate planning lawyer to ensure you take advantage of the gift and estate tax rules to minimize or eliminate your tax liability.

5 Ways to Transfer the Family Business

The following article on business succession planning appeared in the February 10, 2014 issue of Northern Nevada Business Weekly:

JCM ProfileAs a business owner, you will have to decide when will be the right time to step out of the family business and how you will accomplish a successful transition. There are many estate planning tools you can use to transfer your business. Selecting the right tool will depend on whether you plan to retire from the business or keep it until you die.

The transfer can be an emotional minefield where some family members are participants in the business and others are non-participants.  Those participants may feel “obligated” to stay in the family business when they would rather do something else.  In addition, the transfer can be complicated due to estate taxes, gift taxes and capital gains taxes.

Moreover, sometimes the family business is only profitable enough to support one child, even though the non-participants may believe the business’ finances should support them. Or, only some or none of your children may have the abilities or skills to run the business.

Transfer of the family business is further complicated when – as is frequently the case – the family business represents all or nearly all of the parents’ wealth.  Passing the business on to one or more children, while treating all your children fairly, is not easy.

Transparency and communication are vitally important. To achieve the best result, the entire family should receive (1) an explanation of your plan and why you are undertaking a particular strategy; (2) sincere, personal discussions clarifying that you love them equally; and (3) a promise that you are doing your best to be fair to all, while ensuring the future viability of the business.

Here are the 2014 tax exclusion and exemption amounts to consider when analyzing the various alternatives available for the transfer of a family business:

  • The annual exclusion for gifts is $14,000 per donee (meaning husband and wife can each gift $14,000 to a recipient); and
  • The federal gift and estate tax exemption for transfers during life or at death is $5,340,000.

Business sale to the participating child through an installment sale.  This is considered one of the simplest methods of transferring the family business to a child or children.  You can sell shares or partnership interests to a family member.  The benefit of this method is that installments payments can be made over time, which provides an income for you after your retirement. Another benefit is that the purchasing child can better manage his or her cash flow and does not have to come up with a large sum of money at once. However, you will incur capital gains if the business sells for more than what you have invested.    

Gift the business to some children and give cash to the others. Gift taxes are likely to be incurred with this strategy. A more practical concern than paying gift taxes is the fact that you may not have sufficient cash to equalize the value of the business assets going to your other children. This dilemma can be solved with a sizeable life insurance policy which names the non-participant children as beneficiaries. There are various ways to handle the life insurance, including setting up an irrevocable life insurance trust so that the life insurance benefits are not included in your estate for estate tax purposes.

However, if you gift your business, your child will not benefit from the step-up in basis to the current fair market value that is allowed when the business is purchased or inherited. For capital gains tax purposes, your child will step into your shoes and own the business at the basis that you own the business. Assuming the business increases in value over time, your child’s capital gains taxes will be higher. Of course, if the business is never sold, capital gains taxes may not be a concern.

Divide the business: the participating children receive the operating company and the non-participants receive the land and/or buildings used by the business. You could retain the real estate but provide that your children who are not participating in the business inherit it. By retaining control of the real estate during your lifetime, you could collect rent from the operating business to provide income. Later, your children who inherit the facilities could charge rent to their siblings running the operating company. How well your children work together under this strategy depends on family dynamics.

GRAT or GRUT. A more sophisticated business succession tool is a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT). GRAT/GRUTs are irrevocable trusts to which you transfer appreciating assets while retaining an income payment for a set period of time. At either the end of the payment period or your death, the assets in the trust pass to the other trust beneficiaries (the remainder beneficiaries). The value of the retained income is subtracted from the value of the property transferred to the trust (i.e., a share of the business), so if you live beyond the specified income period, the business may be ultimately transferred to the next generation at a reduced value for estate tax or gift tax purposes.

Intentionally defective grantor trust.  Another sophisticated technique is use of an intentionally defective grantor trust (“IDGT”).  The trust is intentionally defective so the grantor pays the income tax on the assets that are no longer considered part of the estate.  You create the IDGT, lend the trust money to buy an asset (the business) you expect will appreciate significantly. In return for lending the trust money, you receive interest payments for a set number of years. The lower the interest rate, the less the trust must repay you — and the more your heirs stand to benefit.

Democrats Divided Over Future of Estate Tax

One tax element overlooked in the negotiations over the “fiscal cliff” is how Congress and the President will resolve the future of the estate tax. The Wall Street Journal reports that several Democratic senators from conservative states will not embrace President Obama’s plan to raise the estate tax.  Under current law, the estate tax exemption amount will be lowered to $1 million with a 55% tax rate starting January 2013. President Obama proposes to return the estate tax exemption amount to $3.5 million with a 45% rate, the same terms as 2009.

Senator LandrieuSenator Mary Landrieu of Louisiana, Max Baucus of Montana, and Mark Pryor of Arkansas said they would prefer not to raise the estate tax.  This week, Ms. Landrieu took a very strong position by stating that she would oppose any deficit-reduction package that raises the estate tax. One common element among Landrieu, Baucus, and Pryor is their party affiliation, another more important aspect is that all three are up for re-election in 2014.  The three are diverging from the Democratic party’s position to endorse a position likely favored by their conservative constituents.

Republican lawmakers continue to support estate tax repeal altogether.  At the very least, the Republican leaders expect a continuation of the Bush-era tax cuts which would maintain the estate tax exemption at $5 million and a 35% tax rate.  Under the current policy, the Tax Policy Center estimates that $161 billion of tax revenue will be generated over the next 10 years.  Under President Obama’s proposal, $276 billion would be raised.  Considering the highly-charged political climate, we may not have a resolution to the future of the estate tax in the near future.

“It’s Your Estate” Lecture Series

Several charities, including the Community Foundation of Western Nevada, are sponsoring a free workshop series titled, “It’s Your Estate.”  The workshops are designed to educate the public in the consumer financial arena and help them take charge of their own money and estate.  Jason C. Morris, Esq.will present on the Advanced Estate Planning topic this week of April 17th – 19th, 2012.  Mr. Morris will present at Northwest Reno Library, 2325 Robb Drive, at 2:30 p.m. on April 17th.  On April 18th, Mr. Morris will present at the Spanish Springs Library, 7100 Pyramid Way #A, Sparks at 11:30 a.m. and offer another presentation at the South Valleys Library, 15650 Wedge Parkway, Reno at 2:30 p.m.  On April 19th, Mr. Morris will present at the Sparks Library, 1125 12th Street, at 11:30 a.m.

Facebook Billionaires Avoid Taxes with GRATs

Forbes recently highlighted how Facebook co-founders Mark Zuckerberg and Dustin Moskovitz established grantor retained annuity trusts (GRATs) to transfer significant amounts of wealth tax-free.  In 2008, Zuckerberg and Moskovitz established GRATs which will enable the Facebook executives to transfer as much as $185 million to future offspring or others without paying any gift tax.  Most wealthy individuals recognize that this year offers a golden opportunity to transfer $5.12 million in assets without incurring any gift tax. However, the Facebook executives followed a similar tax strategy to the Walmart founders, the Walton family, by funding their GRATs with their rapidly appreciating Facebook shares.

ImageGRATs function by allowing a grantor (Zuckerberg and Moskovitz) to place shares or other assets into an ­irrevocable trust and retain the right to ­receive an annual payment back from the trust for a period of time.  Typically, to avoid the risk of premature death, advisors select a shorter time period of 2 to 4 years. If the grantor survives that period, any property left in the trust when the annual payments end passes to family members, other beneficiaries, or another trust.

A crucial aspect is determining the value of the remainder interest in the annuity. In calculating how much value will be left at the end of the annuity term (the remainder) — and thus how big a gift the grantor is making — the IRS does look at the performance of the actual stock (or any other asset) in the trust. Instead, the IRS assumes the trust assets are earning a meager government-determined interest rate. With a zeroed-out, or “Walton” GRAT, the grantor receives an annuity that leaves nothing for heirs if assets grow only at the IRS’ lowly interest rate. If the assets grow faster, the excess goes to the heirs gift tax free. If assets or stock under-perform or decrease in value, there is no downside for the grantor because the annuity can be paid by returning some shares each year to the grantor.

As a result, a GRAT is an ideal instrument to shift assets you expect to suddenly increase in value.  Hence, rapidly appreciating stock of technology giants (Facebook) or growing retails empires (Walmart) have proven to be the perfect assets to utilize within a GRAT.  President Obama and Democrat legislators have targeted zeroed-out GRATs as tax loopholes of the wealthy and have proposed legislation which would eliminate their use.  Until that time, the GRAT remains a valuable wealth transfer tool.