Making the Most out of Year End Gifts to Family

This time of year, many of our clients begin considering making gifts to family members. Some of our clients will use the annual gift-tax exclusion ($14,000 in 2013), to make family gifts tax-free. Others, who desire to make larger gifts to family members, are willing to use of a portion of their lifetime exclusion amount (totaling $5,250,000 in 2013).

Many of our clients attempt to keep things simple by giving cash. "Cash makes no enemies" as they say, but it still can remove a significant amount of assets from a client's estate in the event of future estate tax liability. For example, a couple I represent, who will have a taxable estate, give $14,000 each to a total of 33 children, grandchildren, and great-grandchildren, as well as to spouses of some of those beneficiaries. Each year they give away more than $900,000, which will save over $360,000 in federal estate tax liability at their death. I suggested the clients give interests in LLCs holding real estate rather cash because it would have allowed them to give away more than $1,100,000 under their current gifting scheme. Unfortunately, many of their beneficiaries have gotten used to living outside of their means and need these cash gifts to help balance out their annual expenses.

As I mentioned above, clients can get even greater advantage against future tax liability by using the annual exclusion gifts to give highly appreciating property rather than cash. The current value of the gift and any future appreciation escapes taxation. Giving children a portion of real estate or minority interests in closely held companies are two common methods of taking advantage of this technique. In addition, it is possible to discount gifts or a minority interest for gift tax purposes because of lack of marketability and lack of control. For example, using a 20% discount allows clients to treat a gift of minority interest valued $18,000 as a gift valued at $14,000. Depending upon the asset the clients choose to transfer, sometime greater discounts are possible.

Others of my clients have taken advantage of the possibility of discounts by giving awayclosely held stock or minority interests in LLCs, which may hold real estate or other invested assets. Can clients not only leverage the annual exclusion gifts, but also can actually leverage the lifetime estate tax and gift exclusion. If there is a desire, a client can make gifts above the annual exclusion amount by using some or all of their lifetime exclusion. If only a 20% valuation discount is available, the current $5,250,000 lifetime exclusion could support gifts of over $6,500,000, not including future appreciation. One client in particular gave away a 99% nonvoting interest in an LLC holding real estate that is leased by his other businesses. Not only were we able to use discounts because the interest was nonvoting, but his retained 1% voting interest allows him to control the entity. This particular client did not need the income from the leases so we structured the LLC to distribute that income to the children. Another client used a similar strategy and distributed income to his grandchildren for their education expenses.

Even if the clients do not have a taxable estate, making gifts to children may be a good idea because it allows them to see if their children will use or invest the money wisely. If the children make mistakes with small amounts, they can modify their estate planning documents to provide guidance to children after their deaths so assets are not wasted. In addition, it can allow them to enjoy seeing their children do things and have things while they are still alive.

Any time during the year is a good time to make gifts to help facilitate planning, but as the days grow short and the year nears an end, there is a finite amount of time for clients to take advantage of gifting opportunities using the annual exclusion gifts or lifetime exclusion gifts. It is important for us as planners to help clients understand the opportunities and facilitate good planning. We need to remind them that if an annual exclusion gift is not made in any particular year, it lapses and cannot be carried over to a following year.

This time of year is also an excellent time for clients to consider charitable gifts, and next week we will discuss some of the planning opportunities for charitable donations.

Alan Ferrara and Matt Ferrara