By Stuart G. Schmidt, Esq.
The best estate tax planning technique is to give away assets while you are living. By making gifts during life, the property given will not be subject to the maximum Estate Tax of 40% upon your death. Naturally, you must reserve enough assets to provide for you, and if you are married, your spouse’s care.
When sufficient assets do exist, properly structured gifts can save hundreds of thousands of dollars. While you don’t get an income tax deduction for a gift, the individual who is the recipient does not have to report the gift as income.
The Federal Government will tax any and all property given during life or owned at death. However, before the maximum estate and gift tax of 40% applies, an individual is entitled to a lifetime tax credit. This credit allows each individual to transfer $5,340,000 worth of property tax free in 2014. The credit will shelter gifts made during life and bequests made at death.
The most valuable tax savings that a gift achieves is that it ensures that any future appreciation in the property escapes tax. For example, if you give away stock worth $400,000, which increases to $1,000,000 at the time of your death, you avoided estate tax on the additional $600,000 of appreciation. Such a gift can also achieve income tax savings. If your beneficiary is in a lower income tax bracket, less tax will be assessed when the beneficiaries sells the stock.
A gift can also be planned so that it qualifies for an exclusion and is tax free. The following gifts are exempt from gift tax: (1) gifts to a spouse; (2) gifts of $14,000 annually to any individual and $28,000 if the gift is made by a married couple; and (3) direct payments to an educational provider for tuition or to a medical provider for medical care.
One of the best planning opportunities is use of the $14,000 annual exclusion (adjusted annually for inflation). This exclusion allows a single person to give $14,000 a year to each beneficiary; a married couple can give $28,000 a year. Thus, a couple, by making gifts to each child and grandchild, can reduce their estate by hundreds of thousands of dollars each year. It is important to note that the gift does not need to be cash; it can be an interest in real property, a corporation, or intellectual property.
Because it is beneficial to start these gift giving programs early, the beneficiaries of the gifts are often young children. While some people may be hesitant to make gifts to children, or any other beneficiary who may not be financially adept, there are a variety of ways to limit a person’s access to the money or property gifted. Consider the following:
Crummey Trust: A “Crummey trust,” named after D. Clifford Crummey, a taxpayer who first had this trust created, is a trust designed to accept gifts. Incidentally, D. Clifford Crummey is the second cousin, once removed, of attorney Stuart G. Schmidt.
In order for a gift to qualify for the $14,000 annual exclusion, it must be a “present interest”. This means that the beneficiary must have the immediate right to use and benefit from the gift. Absent the special characteristics of a Crummey Trust, gifts to a trust for ones future benefit will not be tax free, even if it was under $14,000. In order to meet this requirement, the Crummey Trust provides that when property is given to the trust, the beneficiary must have the right to withdraw the gift for at least 30 days. If the minor does not withdraw the gifted property, the gift property remains in the trust under the terms of the trust agreement.
The beneficiary’s right to withdraw the gifted property out of the trust is called a “crummey withdrawal power”. While the beneficiary must be given a legal right to withdraw the money, a withdrawal usually does not occur. Most beneficiaries realize that if they exercise the right, it will be contrary to your wishes, which may jeopardize future gifts.
Once the property is in the trust, the trustee can be required to use the trust property to pay for a beneficiary’s education, healthcare or general support. The trust can also specify at what age or ages the beneficiary is to receive the trust property. A common scenario is for a child to receive 50% of the trust at age 25 and 50% at age 30. However, the trust should be customized so that it fits your goals and the needs of the beneficiaries.
Gifts for Tuition and Medical Expenses: In addition to the $14,000 annual exclusion, educational tuition or medical expenses, such as health insurance, doctor or hospital bills, and prescription costs, you pay directly for your beneficiary are tax free. As long as the check is written directly to the educational or medical service provider, and not to your beneficiaries, there is no dollar limit on the amount of the tax free gift.
Custodianship: A custodianship is created by designating an adult as custodian for a minor to receive the gift under the California Uniform Transfers to Minors Act (“CUTMA”). The custodian controls the management of the gifted property and determines whether to make distributions for the minor until the minor attains age 18 (or until age 21, if you specify another age at the time of creating the custodianship). At age 18 (or the later specified age), the minor must receive whatever property is held by the custodian. You may create a custodianship simply by transferring cash or other property to the adult as follows:
“[Adult’s name] as custodian for [Minor’s name] [Optional: until age 19 or 20 or 21] under the California Uniform Transfers to Minors Act.”
Because many banks and other financial institutions allow its customers to open custodianship accounts, this is a very easy gift giving technique. However, its simplicity also has drawbacks. First, the minor’s access to the money can only be limited to the maximum age of 21, which is often too young. Second, if the one making the gift is the named custodian on the account, the value of the account will be subject to estate tax on the donor’s death. For tax purposes the gift will be ignored and no tax planning will have been achieved.
2503(c) Trust: A 2503(c) trust is a trust provided for by Internal Revenue Code Section 2503(c); where it takes its name. This trust must either terminate automatically when the minor reaches age 21 or the minor must be given a right to withdraw all of the trust property from the trust during a 60-day “window.” If the minor does not withdraw the trust property, the trust can continue for a further period specified in the trust instrument, like a Crummey trust. The advantage of this trust over a custodianship is that it can continue beyond the minor’s 21st birthday, unless the minor elects to withdraw the trust property. However, unlike the Crummey trust, during the 60 day window the child has a chance to withdraw all the trust property. The beneficiaries’ rights to withdraw property from a Crummey trust is limited to the amount gifted in a single year.
Conclusion
A Crummey Trust is the best gifting vehicle and ensures that the tax planning goals are met. It provides almost limitless flexibility. Once the trust is set up it can continue to accept gifts from the original donor or anyone else. It is important to remember that the $14,000 ($28,000 for a married couple) exclusion amount is allowed per year per beneficiary. Therefore, to really take advantage of this annual exclusion, a gift giving program should be started early and include many individuals. After many years of using this technique, substantial tax savings can be gained, while control is maintained.
It is time to review your estate plan. If you don’t yet have an estate plan, it’s time to get it done. Your death or incapacity will be emotionally traumatic for your family; don’t make it legally difficult as well. Contact one of our estate planning attorneys , Stuart G. Schmidt or David J. Lee, to assist in the creation, review and/or update of your estate plan. Our job as your attorneys is to make this process easy and painless and, most importantly, put a proper plan in place. Call us today at (408) 356-3000 or send us an email at sschmidt@smwb.com.
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