Reducing the Taxable Estate

Gifts and Techniques that Reduce Value

by Layne T. Rushforth

Estate-Reducing Techniques: Overview

  • Spending: The first estate-reduction technique is to spend and use up your estate for your own benefit.  You earned it; you spend it. You do not have to leave it to anyone.  You may want to tell your children or other beneficiaries, "If I leave you anything, it is only because I miscalculated."  Most clients do not want to be that aggressive in reducing their estates, but you may want to be a bit more generous with yourself, and -- using one client's example -- "buy a bit of melon in off-season."

  • Gift Giving: Most estate-reduction tools involve some sort of gift giving.  As you know, each person can give up to $15,000 to each of any number of recipients in each calendar year without having to report a taxable gift or use up the applicable exclusion amount ($11,180,000 in 2018 and $11,400,000 in 2019 with a reversion to around $6,000,000 in 2026). Taxable gifts require no out-of-pocket payment of gift tax until the cumulative total of lifetime taxable gifts exceed the applicable exclusion amount.New Window  From a transfer-tax perspective, making lifetime gifts is much more effective than making after death distributions under a will or trust. Consider the following illustration:

    • A lifetime gift of $1 million in the 40% tax bracket would generate a gift tax of $400,000, so the gift and the tax would total $1,400,000, of which the recipients end up with $1,000,000 or 71.4%, making the net transfer tax rate 28.6%.

    • A death-time transfer of $1,400,000 at the 40% rate results in an estate tax of $560,000, leaving $840,000 for the recipients. The true tax rate is 40%.

    • In both examples, the combination of the transfer and the tax totals $1,400,000, but the lifetime gift results in the beneficiaries receiving $160,000 more (and the IRS receiving $160,000 less).

  • Making More Effective Gifts: Some gifts can be more effective than others at reducing the taxable estate.

    • It is common for people to make annual gifts of $14,000 cash to children, grandchildren, and other beneficiaries. This reduces the estate by the amount of the cash and by the amount of its potential earnings.

    • A more effective gift giving technique is to give away appreciating property. This type of gift reduces the estate by the current value of the asset given, as well as by the value of potential appreciation and potential earnings.

    • The best type of gift is a gift that reflects a small value for gift-tax purposes but reduces the estate by a larger value. For example, if you can give a $15,000 gift and reduce your estate by $20,000 or more, you have effectively "leveraged" your gift-tax annual exclusion.

    • Examples of "Leveraged Gifts": Gifts of life insurance, remainder interests, and value-discounted interests are some of the "gift-leveraging" or "gift-maximizing" techniques.

    • Outright Gifts; Gifts in Trust: It is common to make an outright gift to a beneficiary, but it is often appropriate to make gifts through irrevocable trusts. Irrevocable trusts are discussed more fully in the article entitled "Irrevocable Trusts"New Window.

  • Making Large Gifts: Because the federal estate tax applicable exclusion is scheduled to revert to an estimated $6,000,000 in 2026 (more specifically, $5,000,000 plus post-2011 inflation adjustments), some people with large estates are planning to make gifts to use some or all of their full $11,180,000 exclusion before 2026.  After the 2018 mid-term elections, it seems unlikely that there will be any extension of the $11,180,000 applicable exclusion beyond 2025, and that gives further incentive to use up the applicable exclusion that may disappear.  Making large gifts is particularly effective if the assets given have a low current value that is expected to appreciate over time.  There is still a question as to whether a person who uses his or her $11,180,000 exclusion before 2026 and dies after 2025 will find that the estate tax may be imposed on the difference between $11,180,000 and the then-current applicable exclusion.  That issue is not yet settled, but even if the estate tax is imposed on the difference, it will not be imposed on the growth of the assets that were given away.



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