.To Gift or Not to Gift

To Gift or Not to Gift

By TRACY CRAIG, FELLOW, ACTEC, AEP®, Partner and Chair of Trusts and Estates Group  | Mirick O'Connell   September 10, 2019

Sometimes it can be wise (or just pleasurable) to give your assets away while you're still alive.

In estate planning, giving away assets during your lifetime has traditionally been used to help lower estate taxes when you die. However, the federal estate tax exemption amount (the amount under which federal estate taxes do not apply) is currently $11.4 million per person and has been increasing each year due to inflation indexing, so federal estate taxes only apply to 0.1% of people.

The federal exemption amount is scheduled to fall to approximately $6 million (when taking into account future estimated increases for inflation) per person in 2026 (unless Congress changes the law), and even then only about 0.2% of people will be affected.

So, while taking action to avoid federal estate taxes is not necessary for over 99% of the population, there are at least three reasons why gifting may still make sense for you and your family:

State Estate Taxes Could Be an Issue for You

While federal estate taxes aren’t a problem for the vast majority of people, state estate taxes are another story. Twelve states and the District of Columbia currently have a state estate tax, and their exemptions are much less generous than the federal limits — with some as low as $1 million. (See 9 States with the Scariest Death Taxes.) In those states, gifting can help reduce the state estate tax.

For example, in Massachusetts, lifetime gifts are not subject to the Massachusetts estate tax. As a result, by making gifts, the value of the assets you own when you pass will be reduced, and the state estate tax will be lowered.

However, before giving away assets to reduce state estate taxes (which are often graduated and never exceed a top rate of 20%), you need to keep in mind the issue of unrealized capital gains and what is known as the “step up in basis.” At death the fair market value of most assets (except most notably retirement accounts) becomes the tax basis of those assets.

Because most assets appreciate during life, the basis of assets is said to “step up” to the fair market value, essentially wiping away all potential capital gains taxes. This is true even if your estate is not large enough to pay any federal estate tax.

When you give away assets, instead of a step up in basis there is a carryover basis, meaning the recipient takes your tax basis. That means, if you paid $10 for your stock and it was worth $100 when you gifted it, a recipient who sold the shares would pay taxes on the $90 of gain.

However, if you don’t sell the stock in your lifetime, the cost basis resets to the value of the stock on the day you die. So, for example, if you had low basis stock, it could make sense to hold the stock until you die if the state estate tax would be lower than the potential capital gains taxes if the asset were sold.

An important consideration here is that in some cases capital gain taxes can be imposed at higher rates than state estate taxes. Federal capital gains tax rates are 0%, 15% or 20% depending on your income and filing status.

There’s also state income tax to consider, plus an additional 3.8% Medicare tax for higher income earners. (For example, in Massachusetts — where the state income tax rate is about 5% for individuals in a high income tax bracket — combined capital gains tax rates can equal almost 30%.)

Therefore, while gifting to save on estate taxes is possible, it should be analyzed carefully to make sure you don’t inadvertently expose yourself or your loved ones to capital gains taxes.

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