A Few Year End Transfer Tax Planning Ideas

By: Randall A. Denha, J.D., LL.M.

With the federal estate tax exemption now at a record high of $11.4 million per spouse (increasing to $11.58 million in 2020 per spouse), fewer estates will receive an estate tax bill from the federal government. Still, estate planning remains critical as investors seek to manage the distribution of assets as well as meet any state tax requirements. No predictions about the 2020 election, but if the Democrats are victorious, and if they gain enough control over Congress, they’ll try to pass harsh estate tax reforms. Many Democrat hopefuls have spoken about increasing taxes on the wealthy to pay for health care, student loan forgiveness, and more. Regardless of the final shakeout, it is highly likely that transfer and income taxes will change. As to the transfer taxes, the gift tax exemption could be reduced from $11.4 million (2019) to a mere $1 million gift exemption. The estate tax exemption might be reduced from $11.4 million to $3.5 million.
With all of the above in mind, the following ideas are popular tools for making last minute year-end transfers that should be considered:

1. Irrevocable Life Insurance Trust-Funding an Irrevocable Life Insurance Trust (an “ILIT”) and gifting the premium to the beneficiaries on an annual basis (this can be a new policy or, in some cases, an existing policy with an ownership change). When the life insurance owner is changed, it is important to make sure that the cash value of the insurance does not go above the gift tax exclusion in the first year. There are added benefits to forming an ILIT, such as having the death benefit removed from your taxable estate upon your death.

2. Forgive Old Debts-Using the annual gift tax exclusion to forgive old debts of family or friends. In this scenario, it is important to create documentation that will show that the debt has been forgiven to avoid later confusion for your estate.

3. Transfer Stock- Using the annual gift tax exclusion to transfer stock in a privately held company to future generations or management. In this scenario the person making the gift would likely need to make multiple gifts over a number of years to ensure the entire company can transfer and have a business valuation done to peg the value of the interests to be transferred so it can be properly reported for gift tax purposes. However, this is a good way to start getting some of the company into the hands of the next generation.

4. Contribution to a 529 Plan- Making contributions to your children/grandchildren’s 529 plan for their future college or trade school education. These are just a few of the examples we have seen in our office in the past of ways families have taken advantage of the annual gift tax exclusion. This year (and next year in 2020) the exclusion is $15,000 per person per gift. This means if there is a couple with two children and four grandchildren, the couple would be able to gift $15,000 to each of their children, each of their grandchildren and even the spouse of their children for a total gift this year of $240,000. It is also important to note that the annual exclusion does not count towards the lifetime gift exemption.

5. Year End Gifts of Cash, Check, Securities and Joint Accounts

a. A gift by check is only completed when both of the following two events have occurred, (1) the donor has delivered a check to the beneficiary with the intent to make a gift, and (2) the beneficiary has deposited or cashed the check at the beneficiary’s bank. Technically, the donor retains the ability to stop payment on the check, or withdraw funds from the account, until the time the check is presented by the beneficiary’s bank to the donor’s bank, however, courts have ruled that the earlier presentation of the check by the beneficiary to their bank is sufficient to complete the gift.

b. A gift of securities is subject to the same basic rule that a gift is complete only after the donor has unconditionally relinquished all dominion and control over the transferred property. As a result, a donor’s verbal or written instruction to a broker to transfer securities to a beneficiary’s account is not sufficient for a completed gift until the securities are physically transferred and the donor no longer possesses the ability to rescind the transfer instructions.

c. As to a joint account, if another person is added to an existing joint bank account or brokerage account, no gift is made until the other person withdraws on the account for his or her own benefit. The amount of the gift is equal to the amount the beneficiary withdraws from the account without any obligation to repay the donor or use the withdrawn funds for the donor’s benefit.

6. Annual Exclusion Gifts

a. In 2019 and 2020, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it.

b. If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax. It just means you need to file IRS Form 709 to disclose the gift.

c. The annual exclusion is per recipient; it isn’t the sum total of all your gifts. That means, for example, that you can give $15,000 to your cousin, another $15,000 to a friend, another $15,000 to the neighbor, and so on all in the same year without having to file a gift tax return.

d. The annual exclusion also is per person, which means that if you’re married, you and your spouse could give away a combined $30,000 a year to whomever without having to file a gift tax return.

e. Gifts between spouses are unlimited and generally don’t trigger a gift tax return. Gifts to nonprofits are charitable donations, not gifts.

f. The person receiving the gift usually doesn’t need to report the gift.

7. Special Gift Tax Rules

a. Gifts to spouses are generally unlimited, with no gift or estate tax due.

b. Gifts to charity are free of gift tax.

c. Gifts made for tuition and qualified educational expenses don’t have gift tax consequences, but in order to avoid the tax, you have to make payments directly to the college or other educational institution. If you give the money to the student, you don’t get the gift tax break, even if the student then turns around and pays that money to the school.

d. Gifts to cover medical expenses for someone else are also free of tax, under the same limitations: You have to pay the hospital or medical professional directly, rather than giving money to the patient and having the patient pay the bill.

8. Charitable Gifts-If you are looking for additional tax deductions, making a charitable contribution may fit the bill. The following are a few rules to keep in mind:

a. The three basic rules for all charitable gifts:

i. The charity must be qualified by the IRS as a 501(C)3 organization. Request this information from the organization before making the gift to see if it qualifies. Charity Navigator is a useful tool to look up qualifying charities as well as directly accessing the IRS.gov website.

ii. In order to receive a tax benefit, you must itemize your deductions on your federal tax return. Not only that, your adjusted gross income (AGI) level must be below the phase-out threshold in order to utilize the benefit.

iii. You must obtain and retain a receipt that acknowledges payment from the organization. Remember, the IRS requires written evidence of any and all donations.

b. Ways to contribute:

i. You may give the charity a check, money order, and most will accept credit cards. Untraceable cash is not recommended.

ii. You may donate appreciated assets that you have owned for more than a year. Stock, mutual funds, or real estate will all fall under this category. The best part is that you will receive a deduction based on the value of the assets at the time of the donation and avoid paying tax on the appreciation.

iii. If you are older than 70½, you can donate money directly out of your IRA. While you will not get a deduction for this, remember this donation will consist of pretax dollars on which you never paid tax.

c. The timing rules for making charitable gifts are more favorable to taxpayers. A charitable gift by check is deductible by a donor in the year a check is mailed, even if the charity does not cash or deposit the check until the following year. Similarly, charitable gifts charged to a credit card are deductible in the year made, even though the credit card bill is paid the following year. Only donations to qualified charitable organizations are tax-deductible.

For most people, gift taxes will not be a concern since the combined estate and gift tax exemption is so high. However, you are still required by law to report gifts over the annual exclusion amount on a gift tax return (IRS Form 709). Sometimes gifts can be used strategically to avoid estate taxes or to minimize other problems after death. Other times, gifts can cause adverse tax consequence. For that reason, it is always a good idea to talk to an attorney before making a major gift — even if you don’t think you will have to worry about paying estate taxes. Estate and gift taxes are a complicated estate planning topic. Misunderstanding these concepts, or failing to adequately prepare for them, can have dire consequences for your beneficiaries and loved ones.
The holidays are a time of giving, and you shouldn’t let fear of gift tax keep you from making your traditional gifts. With such generous tax breaks available, the gift tax is something that the vast majority of taxpayers will never have to consider — let alone pay.