INTRO: Generosity is widespread. Many people make gifts to loved ones and charities. On the surface, gift-giving is simple and straightforward. Without considering certain financial, tax and control factors, however, it is easy to make a mistake about the timing, type and/or amount of a prospective gift. Ultimately, it may or may not be wise to make the gift at all. In this blog post, I’ll give a few examples of common gift-giving mistakes, some of which can be painful.
Mistake #1: Giving an amount that leaves you vulnerable to a lower quality of life. I have worked with generous clients who concentrate so much on what they would like to give to loved ones that they lose sight of, or convince themselves to sacrifice, their own financial wellbeing. People are living longer. Future financial markets, your long-term health needs and the circumstances of an intended donee are never certain. So, unless you are extraordinarily wealthy, you are well advised to be conservative when making (irrevocable) gifts.
Mistake #2: Failing to take advantage of federal estate and gift tax rules. Federal estate tax and gift tax rules render certain gifts tax neutral. It is wise to seek advice about these rules so you can give in the most tax efficient manner. For example, if you give more than $14,000 (in cash and/or the value of other assets) to any individual(s) during a calendar year, you are required to file a federal gift tax return; and the excess you give to anyone over $14,000 reduces the federal estate tax exemption available on your death. Additionally, you are able to give (pay) an unlimited amount to healthcare providers and educational institutions for the benefit of a loved one as long as the payments are made directly to the provider.
Mistake #3: Missing the opportunity to designate a charitable organization(s) as beneficiary of your retirement plan (e.g. IRA or 401K). If you’re charitably inclined, you should consider designating one or more charities as beneficiary of your retirement plan rather than as beneficiary of your living trust. Charities enjoy a tax-exempt status. So, when a charity withdraws funds from the retirement plan it inherits from you, it pays no income tax and therefore enjoys 100% of the plan funds. Alternatively, when your loved one is the beneficiary of your retirement plan (assuming you funded it with pre-tax dollars), your loved one will pay federal and state income tax on the amounts he or she withdraws, and will thus enjoy as little as about 60% of the plan funds.
Mistake #4: Making lifetime versus testamentary gifts of appreciated assets. Elders are often inclined to make lifetime gifts of highly appreciated assets, such as a principal residence, vacation home or investment property, to children or other loved ones. However, if your loved ones instead receive such appreciated asset on your death, they receive a major income tax benefit known as a “step-up” in income tax basis. This allows the inheritor to sell the asset and pay no income tax on the sale. Alternatively, if you gifted the same asset during your life and your loved ones sold the asset, they would step into your shoes and be liable for income tax just as you would have been if you had sold the asset. Accordingly, it behooves you to talk to your tax advisor to determine how compelling the basis “step-up” will be if you keep an appreciated asset and gift it on your death (e.g. through your living trust) rather than during your life.
Mistake # 5: Gifting to minors into a custodial account. Many people make substantial gifts to minors into custodial accounts without realizing that the minor for whom the account is established will irrevocably own and control the funds upon reaching 18 – the age of majority (or as otherwise set up when establishing the account – in California, no older than 25). Instead, by creating an irrevocable trust for the minor, you can meaningfully control the disposition of funds to the child before and after he or she reaches a certain age(s) and/or satisfies certain conditions that you, the donor, deem necessary or appropriate. You can name a trustee and successor trustees in whom you have confidence to manage and distribute the funds prudently to the beneficiary.
This article is intended to provide information of a general nature, and should not be relied upon as legal, tax, financial and/or business advice. Readers should obtain and rely upon specific advice only from their own qualified professional advisors. This communication is not intended or written to be used, for the purpose of: i) avoiding penalties under the Internal Revenue Code; or ii) promoting, marketing, or recommending to another party any matters addressed herein.
Mr. Silverman is an attorney with R. Silverman Law Group, 1855 Olympic Blvd., Suite 125, Walnut Creek, CA 94596; (925) 705-4474; email@example.com.
ESTATE & TRUST ADMINISTRATION: Need to find an experienced estate & trust administrator in Walnut Creek CA? Contact Robert Silverman at 925-705-4474 for legal advice on a Revocable Living Trust, “Summary” Estate Administration, Trust/Estate Beneficiary Representation and Will & Trust Disputes.