The Tax Benefits of Lifetime Gifting

The Tax Benefits of Lifetime Gifting

Over the last five or six years, many estate planners have seen an uptick in client interest when it comes to making lifetime gifts (rather than waiting to pass their assets at death).  The gift and estate tax benefits of lifetime gifting are driven, first and foremost, by the value of the net assets that are either owned or controlled by the taxpayer.  Under the federal tax law in effect for 2023, each U.S. citizen or resident may—either during their lifetime or upon their death—give away up to $12.92 million to non-charitable, non-spouse beneficiaries without incurring gift or estate tax (which is often referred to as the “lifetime exemption”); but a 40% gift tax or estate tax will apply to the extent that the cumulative amount of all such taxable transfers exceeds the lifetime exemption then in effect.  That said, the amount of this lifetime exemption, which is adjusted annually for inflation, will effectively drop in half in 2026 if Congress does not act to change the current law.

Tax Benefits of Lifetime Gifting

For taxpayers with net assets sufficient to warrant estate tax planning under the current law, or for taxpayers who believe that the law may change to their detriment, lifetime giving may offer the following tax advantages.

Use of the High Lifetime Exemption.

Although the lifetime exemption is currently slated to drop in half in 2026, the U.S. Treasury has indicated that, in most instances, it will not tax gifts that were sheltered by the lifetime exemption that was in effect when the gifts were made.  In essence, affected taxpayers have a use-it-or-lose-it opportunity. For example, if a taxpayer makes cumulative lifetime taxable gifts of $12.92 million by the end of 2023 and dies in 2026 with the current law still in effect, her beneficiaries would likely realize a net estate tax savings of over $2 million just from the use of the higher lifetime exemption.

Estate Freeze

In many cases, the most significant benefit of lifetime giving is shifting post-gift appreciation out of the taxpayer’s taxable estate. For example, if a taxpayer makes a taxable gift of $12.92 million to an irrevocable trust for his family in 2023 and the trust assets grow to $18 million by the time the taxpayer dies in 2026, the beneficiaries of his estate (presumably, the same beneficiaries of the trust) could reduce the estate tax by $2 million. Furthermore, the after-tax growth from this “estate freeze” can be enhanced by designing the terms of trust to allow the taxpayer to continue paying the income taxes on behalf of the trust (which is not considered an additional taxable gift).

Use of Gift Tax Annual Exclusions

Under the law currently in effect, in each calendar year, each taxpayer may make direct gifts of up to $17,000 to each individual donee (or a carefully drafted trust whereby the donee has the right to withdraw contributions) without giving rise to a “taxable gift” that exhausts the taxpayer’s lifetime exemption.  The benefits of annual exclusion gifts may seem relatively inconsequential in light of the current amount of the lifetime exemption, but every dollar taken off the top of a taxpayer’s taxable estate could result in 40 cents of estate tax savings.

Lower Effective Gift Tax Rate

With respect to large estates that will almost certainly face an estate tax, making lifetime taxable gifts in excess of the lifetime exemption and paying gift tax may be preferable to imposing an estate tax on the beneficiaries.  Under the current law, when a taxpayer pays the gift tax on a taxable gift, the assets used to pay the tax are not considered part of the taxable gift, and the taxpayer’s taxable estate is reduced by the amount used to pay the tax if the gift is made more than three years prior to death; but if the taxpayer did not make the gift, the larger taxable estate would include those assets that will have to be used to pay the estate tax.  Thus, even though the statutory tax rates may be the same for taxable gifts and taxable estates, the effective gift tax rate may prove to be lower.  That said, there are risks and costs to pursuing this strategy.  If the statutory estate tax rate decreases (relative to the current gift tax rate) or the lifetime exemption increases significantly from the date that the gift is made to the date that the taxpayer dies, the gift tax liability could exceed what would otherwise be paid as estate tax on the gifted property at death.  Furthermore, there is the time value of money to consider in light of the fact that the taxpayer (usually) will not know the date of his or her death: a dollar of gift tax paid today is worth more than a dollar of estate tax paid at some indeterminable point in the future.

State Death Tax Savings

Currently, 17 states and the District of Columbia impose an estate tax or inheritance tax upon gratuitous transfers that occur at death at marginal rates that can range from 0.8% to 20%; but only one state (Connecticut) also incorporates a gift tax on lifetime gifts.  Although jurisdictions like New York include gifts made within three years of death within its estate tax base, as a general matter, the reduction in one’s taxable estate through lifetime gifts may also result in state death tax savings if the taxpayer is a resident of, or owns property located in such a state.

Income Tax

All of that said, there may be an income tax cost to making lifetime gifts of assets that increase in value. Generally speaking, an asset included in the taxable estate for estate tax purposes receives a new income tax basis equal to the fair market value at death for purposes of computing any capital gains tax upon disposition of the asset; however, an asset received by lifetime gift does not receive such a “step up” in basis. That said, the gift and estate tax rate (under the current federal tax law, 40%) well exceeds the highest effective long-term capital gains tax rate (under the current federal tax law, 23.8%).

Of course, any proposal for lifetime giving should be considered holistically as part of a client’s overall estate plan.  That said, the professionals at The Innovative CPA Group LLC have the knowledge and experience to assist each client and their other professionals in assessing the relevant circumstances and quantifying the potential tax benefits of lifetime gifting and costs.

If you require any assistance or clarification regarding lifetime gifting, don’t hesitate to reach out to our knowledgeable trust and estate accountants for expert guidance. 

Article written by Steven Baker, CPA, Esq.

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2023-11-16T15:27:39+00:00October 25th, 2023|Estates and Trusts, Individual|

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