Gifting Strategies for Estate Planning — CFP Exam Review

The annual gift tax exclusion allows individuals to gift a certain amount of money or property to any number of donees each year without incurring gift tax or using up their lifetime gift tax exemption. For 2024, the annual exclusion is $18,000 per donee. This amount is indexed for inflation and can change annually.

Married couples can elect to split gifts, effectively doubling the annual exclusion to $36,000 per donee, even if only one spouse owns the gifted asset. To utilize gift splitting, both spouses must consent on IRS Form 709 (United States Gift (and Generation-Skipping Transfer) Tax Return), and they must be married for the entire calendar year.

For example, if John wants to gift $30,000 to his daughter in 2024, and he is married to Mary, they can elect gift splitting. John reports $18,000 of the gift, and Mary reports the remaining $12,000. This eliminates any gift tax implications and avoids using any of John's or Mary's lifetime gift tax exemption.

To qualify for the annual gift tax exclusion, a gift must be of a present interest, meaning the donee has immediate access to and enjoyment of the gifted property. Gifts to trusts often pose a problem because the beneficiary doesn't have immediate access. A Crummey power is a provision in an irrevocable trust that gives the beneficiary a temporary right to withdraw contributions to the trust, thereby converting what would otherwise be a future interest gift into a present interest gift.

The beneficiary must be given reasonable notice of their withdrawal right (typically 30 days). If the beneficiary does not exercise the withdrawal right within the specified period, the right lapses, and the funds remain in the trust. The amount subject to the Crummey power is typically limited to the annual gift tax exclusion amount.

Without a Crummey power, contributions to an irrevocable trust would be considered future interest gifts and would not qualify for the annual gift tax exclusion, potentially triggering gift tax or using up the donor's lifetime exemption.

Section 2503(e) of the Internal Revenue Code provides an unlimited gift tax exclusion for payments made directly to an educational institution for tuition or to a medical provider for medical expenses. These payments do not count towards the annual gift tax exclusion or use up any of the lifetime gift tax exemption.

The payments must be made directly to the qualifying educational institution or medical provider. Payments for room and board, books, or other expenses do not qualify for the tuition exclusion. Similarly, payments for health insurance premiums do not qualify for the medical expense exclusion.

This exclusion can be a powerful estate planning tool, allowing individuals to significantly reduce their taxable estate without incurring gift tax consequences. For example, grandparents can pay for their grandchildren's college tuition directly to the university, even if the tuition exceeds the annual gift tax exclusion amount, without any gift tax implications.

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts are custodial accounts established for the benefit of a minor. The custodian (typically a parent or grandparent) manages the account until the minor reaches the age of majority (usually 18 or 21, depending on the state), at which point ownership of the assets transfers to the minor.

Pros: UGMA/UTMA accounts are relatively simple to establish and manage. Gifts to these accounts qualify for the annual gift tax exclusion. Cons: Once the minor reaches the age of majority, they have complete control over the assets, regardless of their financial maturity. Assets in UGMA/UTMA accounts are considered the minor's assets and can impact their eligibility for financial aid.

Tax Implications: Earnings within the account are taxed to the minor. The Kiddie Tax rules apply, meaning that unearned income above a certain threshold is taxed at the parent's marginal tax rate (or the trust and estate tax rates, if higher). Gifts to UGMA/UTMA accounts are irrevocable.

529 plans are tax-advantaged savings plans designed for education expenses. Contributions are not federally tax-deductible, but earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses (tuition, fees, books, supplies, and certain room and board costs at eligible educational institutions). Some states offer state income tax deductions for contributions.

While there are no annual contribution limits, contributions exceeding the annual gift tax exclusion may trigger gift tax. However, a special election allows donors to front-load up to five years' worth of annual gift tax exclusions into a 529 plan in a single year. In 2024, this would be $90,000 ($18,000 x 5). If the donor dies before the end of the five-year period, a pro-rata portion of the contribution is included in their estate.

For example, in 2024, Sarah contributes $90,000 to her granddaughter's 529 plan, electing the five-year averaging. If Sarah dies two years later, $54,000 ($90,000 * 3/5) will be included in her gross estate.

An Irrevocable Life Insurance Trust (ILIT) is an irrevocable trust designed to hold a life insurance policy. The primary purpose of an ILIT is to remove the life insurance proceeds from the grantor's taxable estate. Premiums paid to the ILIT to fund the life insurance policy are considered gifts to the trust beneficiaries.

To qualify for the annual gift tax exclusion, the trust must include Crummey powers, giving beneficiaries the temporary right to withdraw contributions to the trust. Without Crummey powers, premium payments would be considered future interest gifts and would not qualify for the annual exclusion.

The ILIT owns the life insurance policy, and upon the insured's death, the death benefit is paid to the trust. The trustee then manages and distributes the proceeds according to the trust's terms, typically for the benefit of the beneficiaries. Because the insured does not own the policy at the time of death, the proceeds are not included in their taxable estate.

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust where the grantor retains the right to receive a fixed annuity payment for a specified term. At the end of the term, the remaining assets in the trust pass to the beneficiaries, typically the grantor's children.

The goal of a GRAT is to transfer assets to beneficiaries with minimal gift tax implications. The value of the gift is calculated as the fair market value of the assets transferred to the trust, less the present value of the retained annuity payments. If the assets in the GRAT appreciate at a rate higher than the IRS's Section 7520 rate (the discount rate used to value the annuity payments), the excess appreciation passes to the beneficiaries gift-tax-free.

A "zeroed-out" GRAT is structured so that the present value of the annuity payments is equal to the fair market value of the assets transferred to the trust, resulting in a taxable gift of zero (or very close to zero). This strategy is effective when asset appreciation is expected to be high. However, if the grantor dies during the GRAT term, the assets are included in their estate.

The basis of an asset received as a gift is generally the donor's adjusted basis (carryover basis). If the fair market value of the asset at the time of the gift is less than the donor's basis, the donee's basis for determining a loss is the fair market value at the time of the gift.

Assets inherited through a will or trust receive a step-up in basis to their fair market value on the date of the decedent's death. This can significantly reduce or eliminate capital gains taxes if the beneficiary sells the asset.

For example, if John gifts stock to his daughter with a basis of $10 per share and a fair market value of $20 per share, her basis is $10 per share. If she later sells the stock for $25 per share, she will have a capital gain of $15 per share. However, if John bequeathed the stock to his daughter, her basis would be $20 per share (the fair market value on the date of his death), and if she sold it for $25, her capital gain would be only $5 per share.