Gift transfers can reduce estate taxes - column

Healthcare Financial Management, April, 1990 by William G. Kistner

One way to reduce estate assets and ease inheritance tax burdens involves creating a gift giving program.

The gift tax, an excise tax based on the value of property at the time of a gift, is assessed according to the amount of taxable gifts made during a calendar year. With proper planning, gifts may be excluded from taxes altogether.

Most often, gifts take the form of cash and other personal property, such as stocks and bonds. Other possibilities include making interest-free loans, paying another person's expenses, purchasing life insurance, forgiving debts, or creating family partnerships and trusts.

EXCLUSION LIMIT. In most cases, each donor may receive a gift tax exclusion of up to $10,000 per recipient. This is perhaps the easiest and most cost effective way to transfer wealth without depleting a person's gift and estate tax unified credit.

A married couple can agree to split gifts, transferring $20,000 per year tax free to each recipient. If certain residency and citizenship requirements are met, tax-free gifts between spouses are unlimited.

Certain medical and tuition expenses are excluded from gift taxes. To qualify for the exclusion, payment must be made directly to the organization providing the medical care or education.

Payment can be made on behalf of any individual, and no relationship to the donor is required. Medical and tuition gifts can be given in addition to the $10,000 exclusion.

MINORS. Gifts often are made from parents to children, but difficulties may arise if the child is a minor and unable to manage his or her affairs. To alleviate problems, the two most common forms of transfers to minors are through trusts or under a uniform transfers to minors act (UTMA). Most states have adopted UTMAs, which usually require appointing custodians to manage the financial affairs of minors. Under a UTMA:

* A custodian manages all property, including collecting and investing income and other proceeds. The minor retains legal title to the property; The property is turned over to the child at an age determined by each state;

* The property can be used for a minor's support; an

* Various other procedures ensure that a custodian acts in the minor's best interest. If terms of the acts are followed, gifts to minors qualify for the $10,000 exclusion. Trusts offer another way of making qualified gifts to minors. Gifts in trust generally are eligible for the $10,000 exclusion if the trust document contains these provisions:

* The trust property can be used by or for the benefit of a minor at a trustee's discretion; and

* The property passes to the child at age 21 or is payable to his or her estate if the child dies before age 21. However, the child may extend the trust beyond age 21. UNIFIED CREDIT. A gift tax most often is imposed on lifetime transfers, while an estate tax applies to bequests. Currently, each individual may receive a unified credit of $192,800 against estate and gift taxes. This allows an individual to transfer $600,000 of property tax free during his or her lifetime or at death. Many people use the exemption with lifetime gifts because post-gift appreciation can create an estate tax savings. For example: A 44-year-old donor with net assets of $2 million gives $600,000 worth of stock to his children in 1990. The donor's investment in the stock at the time of the gift is $200,000. Any appreciation and income from the stock after the gift date will be taxed to the children and excluded from the donor's estate. If the stock is worth $1 million at the death of the donor, $400,000 ($1 million death value minus $600,000 value at the gift date) will have been transferred tax free.

GIFT VS. BEQUEST. If the stock is transferred as a gift, the investment amount (or basis) of the stock to the children is the same as the donor's: $200,000. Any gift tax paid on the original gift also would be added to the basis. If the stock is sold for $1 million, a gain of $800,000 results ($1 million selling price minus $200,000 basis).

Under a combined Federal and state income tax rate of 33 percent, the children will share $736,000 after taxes. Cash available may be even greater if legislation for a capital gains exclusion currently under debate is enacted by Congress.

If the children receive the stock from the donor's estate, the estate receives a step-up in basis to the fair market value of the stock at the time of death: $1 million. Under a 50 percent estate tax rate, the children will received $500,000 in stock. Because the basis of the stock is $500,000, no gain would be recognized if it were sold for $500,000. Under this scenario, the children would share $500,000.

William G. Kistner CPA, is a tax partner with Ernst & Young in Chicago, Ill. Reader's comments and questions are encouraged and can be addressed to: William G. Kistner CPA, Ernst & Young, 150 S. Wacker Dr., Chicago, IL 60606