Other Planned Gifting

While gifting strategies can involve millions of dollars and extensive family businesses, they can also take a much smaller form, allowing parents to make gifts to children to assist in the purchase of a home or other investment opportunities. Coupled with intra-family lending strategies it is even possible to greatly exceed the annual gifting limits.

Eric and Fran have two children, Georgia and Haley, with whom they are very close. Circumstances had led to the daughters, along with their husbands, living a significant distance from Eric and Fran. A significant factor in this situation was the high cost of property near Eric and Fran’s home, keeping the daughters in their young marriages from affording to live closer to their parents. Eric and Fran had done fairly well for themselves and have the flexibility to assist their children, but want to do so in a way that does not completely provide the daughters and their husbands with a handout. 

Through a series of discussions with us, each other, and a realtor, Eric and Fran located a large parcel of land for sale in an area that was centrally located for all three families. They then proposed that if the daughters and their husbands were willing to build a home on the property, Eric and Fran would purchase the land and divide it into three parcels so that the family could all be close together. This land division would take the form of a gift where Eric and Fran would each give each of their daughters and each husband a gift of interest in the land on December 31st and January 1st of the following year. This complex gift allowed Eric and Fran to each give $14,000 of value to each of their daughters ($28,000 from both parents together) plus the same amount to each son-in-law. They then repeated the gift the next day so that within the span of twenty-four hours Eric and Fran had effectively gifted $112,000 in land to each of their children. 

While this initial gift allowed Eric and Fran to bring their family back together, it was only half of the plan they eventually put into place. Once Georgia, Haley, and their husbands owned the land, there was still the matter of building houses. After working with builders and architects to create designs for all three homes, construction was set to commence.  Instead of funding the construction with a standard building loan, Eric and Fran had the means to loan each of their daughters the cost of construction. They did this much like a normal loan, documenting the whole process and including with the loan a mortgage on the property and residence, which insured that Eric and Fran would be repaid, and gave them a priority lien on the property in the event their daughters ever found themselves in financial dire straits. 

A significant benefit of this intra-family loan was the ability for Eric and Fran to use the IRS’s Applicable Federal Rate (AFR) as the interest rate for the loans, instead of using a standard bank rate. While bank rates at the time were relatively low, the AFR for a short-term (under three years) intra-family loan was under 1% annually. This allowed Eric and Fran to establish loans to their daughters that would save the daughters thousands of dollars in interest payments over the lifetime of the loan. The monthly loan payments were amortized over a normal 30-year period with a balloon payment at the end of three years, the intention being that the loans be “refinanced” at the three-year mark to pay the balloon payment and every three years thereafter to continue to take advantage of the very low short-term AFR. 

While all of these steps provided a great benefit to Georgia and Haley, Eric and Fran wanted to build in one more benefit to their daughters (and their sons-in-law). Each year after the creation of the loans, if each couple made all of their required payments on time and in full, Eric and Fran would make additional “gifts” to reduce the principal of the loan. These gifts are always less than the annual exclusion and therefore will never impact the couple’s lifetime exemption. Eric and Fran also like the idea that the future gifts are discretionary (and not guaranteed or required) and that they are not simply handing their daughters money that they will not fully appreciate. If Georgia, Haley, and their husbands follow through with their obligations in full (and Eric and Fran continue to make annual gifts), they will enjoy fully paid off homes in a burgeoning Michigan community in less than ten years, a significant advantage and one that will not incur any gift tax liability for anyone involved. 

We cannot state enough that this and every other strategy we discuss in this blog involve complex planning and should not be attempting without consulting experienced attorneys and other advisors to ensure that expensive errors to not occur. 

Matt and Al

'Tis the Season for Gifting

Since restarting the blog we have focused primarily on basic estate planning concepts, explaining the various documents and how they work together to create a plan to address the uncertain and unexpected changes that come along during life. Over the next few blogs we are going to move into some more complex planning issues and address how they can be part of an estate plan. In the spirit of the season, we will start with the topic of gifting.

Any time of the year, but especially during the holiday season, clients often consider how they can help their loved ones by gifting cash or other property to them. Obviously the inclination to gift is important, but in the context of estate planning, gifting is generally associated with the tax implications of transferring assets, be it money, real estate, business interests, or any other property. The tax implications of gifting are a pressing issue because the Internal Revenue Code (the “Code”) imposes a Gift Tax on any gifts above a certain level.
The Code treats gifts during lifetime and at death in a similar manner considering them both transfers of wealth that may be taxable if the gifts exceed a certain value. The general rule is the Code imposes a tax on the transfer of wealth, but there are a number of exceptions to the general rule. First, gifts to a spouse are not taxed, unless the donee spouse is not a U.S. citizen. Second, gifts to anyone (relatives or otherwise) to pay for education or medical services are also exempt from gift tax as long as those gifts are paid directly to the school or provider. Third, there is an “Annual Exclusion” amount that allows a person to make as many gifts as they want, to as many people as they want, as long as the total gifts to a single person in a year are under a certain amount known as the Annual Exclusion (currently $14,000.00 and rising to $15,000.00 in 2018).

If a gift to any one person exceeds the value of that Annual Exclusion it counts against the giver’s Unified Credit which can be used during lifetime or at death. The Unified Credit translates into an “Exclusion Amount” which is currently $5,450,000.00 and set to rise to $5,600,000.00 in 2018. The Exclusion Amount can be used to protect transfers at death from Estate Tax or gifts during lifetime from Gift Tax. Each dollar of the Exclusion Amount used by a person during their life reduces their Exclusion Amount at death. If a married person does not use their full Exclusion Amount during lifetime or against Estate Tax at death their surviving spouse can add any unused portion of that Exclusion Amount to their own Exclusion Amount. The result of all of these exclusions is that a married couple can give away in excess of $11,000,000.00 in their lifetime without ever paying any tax on those gifts, which currently make the Gift Tax a very low impact tax, except in the case of high net worth individuals. Congress is currently debating changes in estate and gift taxation. If changes become law, we will discuss this then.

Because for the majority of the population has little worry about making taxable gifts, why is gifting a concern in estate planning? In our experience, issues with gifts revolve more around the personal impact of gifts to the donee rather than the legal impact. People commonly express concerns about gifting different amounts to different children, the impact of making gifts to children who may not make good use of the assets, their own financial security if they choose to make gifts, and the impact of gifting on other aspects of planning, including Medicaid. The stress and anxiety of these questions frequently outweighs a person’s concern about writing a check or turning over control of another asset.

When assisting clients navigating these issues we focus first on the client and ensure that the gifting is both the client’s desire and that the gift will not have a negative impact on the client, either currently or long-term. We remind our clients that they worked hard to accumulate the assets they have and that they should not give away anything that would result in a negative impact to their own lifestyle. Once the client is comfortable their own needs are taken care of, we can then discuss with them their particular situation on how to make gifts to assist loved ones, yet attach strings to protect against the known failings of those loved ones.

It is possible to use Trusts to make gifts to children or grandchildren, but place limits on the use of those gifts and also protect those gifts from creditor problems. One can also structure an intra-family loan that uses gifting to return loan payments to children at the end of the year (or simply provide children with the funds to make the loan payments). It is possible to structure the terms of a Living Trust to take into account gifts made to beneficiaries during lifetime and offset distributions from the Living Trust by the value of the lifetime gifts so that children ultimately receive the same distributions whether during their parent’s life or at death.

Gift planning, as with any other type of tax planning, should never let the “tax tail wag the dog”. By this we mean while it is important to consider the tax ramifications of the gift, it is more important to make sure the gift makes sense after a sound analysis, and then consider strategies enabling the avoidance of taxation. As we always stress, working with an attorney experienced in the legal obstacles and solutions is critical to avoiding mistakes and unanticipated consequences.

Matt and Al

Changes to Gift Tax Exclusions for 2018

Bloomberg and Thomson Reuters released their predictions for 2018’s inflation-adjusted figures related to the Unified Estate and Gift Tax Exclusion amount and the Annual Gift Tax Exclusion this week. While these are not final numbers released by the IRS, they are likely to reflect the 2018 increases.

For gifts made and estates of decedents dying in 2018, the Estate and Gift Tax exclusion amount will likely increase to $5,600,000 (up from $5,490,000 for gifts made and estates of decedents dying in 2017). This increase raises the threshold for Estate and Gift Tax liability to $11,200,000 for married couples.

For gifts made in 2018, the Annual Gift Tax Exclusion will also likely increase to $15,000  per person (up from $14,000 for gifts made in 2017).

Finally, the Exemption from Generation-Skipping Tax (GST) is will likely increase to $5,600,000 for transfers in 2018 (up from $5,490,000 for transfers in 2017).

These increases will allow clients to make further use of planning strategies which allow them to reduce their tax liability by making gifts during their lifetime. Feel free to call or email us if you have any questions or if you want to discuss planning strategies.

Alan & Matt

Gifting $5 Million Without Using $5 Million Worth of Lifetime Exemptions

A few weeks ago we discussed the concept of using limited liability companies ("LLC's") for gifting purposes. We have been working with clients using such a strategy and this gives us an opportunity to explain how the concept works.

     Among other assets, John and Jane have commercial buildings valued at $10,000,000, which are likely to double in value over the next 10 years. The clients also have two children and six grandchildren, all of whom are adults. They were not opposed to lifetime gifting to remove assets and the future appreciation from their estates, but they wanted to maintain control of the assets.

     We suggested that John and Jane transfer the buildings to an LLC, in exchange for a 2% voting interest in the LLC and a 98% nonvoting interest in the LLC, which they then divided equally between themselves. We then discussed what portion of the interests they wanted to gift to their children and grandchildren. Since one goal was to ensure that John and Jane maintained control of the buildings, they will definitely retain ownership of the voting interests. They also wanted to enjoy some of the annual income generated by the buildings, so they will need to retain a portion of the nonvoting interests. Ultimately, John and Jane chose to gift 50% of the nonvoting interests to their children and grandchildren.

     Since John and Jane gifted nonvoting interests, which do not give the owner of that interest control of the business, the IRS will allow a discount of the value of the interest gifted for gift tax purposes. Thus, even though John and Jane gifted an equivalent of $5,000,000, because of the discount (conservatively at 20%) the deemed gift was only $4,000,000. John and Jane each used their annual exclusion gifts of $14,000 to make gifts to each of the children and grandchildren, for a total of $224,000 ($14,000 x 2 grantors x 8 descendants). The remaining gift of $3,776,000 was divided equally between John and Jane's lifetime exemptions against estate tax and we filed a gift tax return providing the IRS with a record of the transaction.

    As an additional protection against creditors and any potential divorce, we also established irrevocable trusts for each of John and Jane’s children and grandchildren to hold the gifted nonvoting interests. These trusts have flexible provisions regarding the distribution of income and principal to the beneficiaries, while also creating a nest egg for later in their lives. 

     The net result of this strategy is that John and Jane maintain control of the buildings during their lifetime and removed assets presently valued at $5,000,000 from their estates using only a portion of their lifetime exemptions. In addition, the transfer removes all of the appreciation on the gifts from John and Jane's estates, saving approximately $2,000,000 of estate taxes at their deaths (appreciation of $5,000,000 x 40% estate tax). In addition, income earned by the gifted interests is now reported on eight different income tax returns and presumably taxed at lower tax rates.

     In this situation, an estate tax savings was one of the desired results. However, even if clients do not have an estate tax issue, gifts of LLC interests to irrevocable trusts can provide children and grandchildren with an income stream, while protecting the interests from creditors or possible marital issues. This strategy is not without additional cost, as appraisals of both the asset value and the minority discount must be completed by a qualified appraiser. In addition, attention must be paid to the administrative requirements and tax filings of both the LLC and the irrevocable trust. As always, clients should seek the advice of a qualified professional before engaging in the strategy.

Using LLCs to Expand Lifetime Gifting

So far, our discussion regarding the use of gifting an estate plan has revolved primarily around cash gifts, it is important to understand that gifts can consist of any type of property, including interests in real estate and business entities. A family owned Limited Liability Company is an excellent tool for transferring a variety of assets from one generation to the next, often at a reduced value, while allowing parents to retain control of the assets during their lifetime.

     While the use of cash gifts provides clients with a tool for reducing their potential estate tax liability, clients may be able to gain greater benefits through by using a Limited Liability Company (LLC) in their estate planning. The client can establish an LLC with two classes of Membership Interest, voting and nonvoting, and can retain control over assets by keeping the voting interests and gifting the nonvoting interests to beneficiaries..

     To make use of this gifting strategy, clients first establish a LLC (or modify an existing LLC) with a 1% Voting Member Interest and a 99% Nonvoting Member Interest. This allows the owner of the 1% Voting Member Interest to control the company regardless of who owns the 99% Nonvoting Member Interest. Clients then transfer ownership of other assets, such as real estate or business interests, to the LLC. Now the client is able to make gifts of the Nonvoting Member Interest, without giving up control of the assets. This allows clients to begin transferring highly appreciating assets during their lifetime, reducing any potential estate tax liability because the appreciation of the assets is now out of the Estate, and providing a potential source of income to their loved ones. Clients can transfer these  Nonvoting Member Interests in the LLC using either their lifetime estate exemption and/or their annual gift tax exemption, further reducing potential tax liability. These nonvoting member interests can be given to adult children as well as minor children and grandchildren, with trust holding the interest for these minors. These trusts can then be used to provide funds for education for the minors as income is distributed from the LLCs

     Another benefit of including an LLC in an estate plan is the potential to receive a valuation discount when making gifts of Nonvoting Member Interests. The IRS recognizes that a member interest in an LLC which does not allow the owner control over the company and which restricts the owner's ability to sell or transfer the member interest has less value than an unrestricted interest. Thus, a properly structured LLC may allow clients to transfer larger portions of the Nonvoting Member Interest as part of an annual gifting plan. While using an LLC in this manner is a well-established practice, it is important to acknowledge that without proper appraisals and planning, and such transfers may be subject to IRS scrutiny.

     In order to comply with the law and IRS regulations is important to manage and operate the family-owned LLC as a separate entity, and not just an extension of the client’s own affairs. The LLC should not contain all of the client assets, especially not the client’s residence, because the IRS argues that the LLC is necessary to maintain the client’s lifestyle and therefore, under estate tax rules, the IRS may deem the LLC's assets part of the client’s estate.

     For many clients the use of an LLC as part of their estate planning is an excellent strategy to increase the value of annual gifting. It is also an excellent tool for transferring ownership of family-run businesses to the next generation while ensuring that the clients retain control of the business operation. It is important to remember that this is a complex planning technique that clients should not attempt without consulting qualified professionals for assistance in reviewing the tax and legal implications.

The Benefits of Intra-family Lending

With this blog, we return to the subject of gift planning. Clients like the idea of reducing taxes with gifting, but the problem is they actually have to give away an asset. When the client expresses an interest in gift planning, We ask them "What amount of assets do you have to own to feel comfortable giving away something?" The answer is usually "just a little bit more!”

     A common issue that arises when we discuss gift planning with a client is the desire to assist their children without giving up control of the assets. One strategy used in this situation, which allows clients to provide funds for family members' use while still protecting the client’s own interests, is intra-family lending. 

     An intra-family loan works much like any other loan, parents loan money to a child for a specific amount of time and at a specific interest rate. For example, a client agrees to lend $200,000 to her son to help finance a business purchase. The son signs a promissory note with specific repayment terms and a mortgage on the new business as security for repayment of the loan. This intra-family loan allows the son to purchase a business he could not otherwise afford and begin securing his own financial future. The client, over time, will get an annual interest payment as well as a return of her principal. If the child's business earns more than the principal and required interest, the child benefits from the loan, and the client has effectively transferred wealth to her son that he would not otherwise have had. 

     While the annual interest payment and opportunity to run their own business are clear benefits to the client and her son, the benefits of an intra-family loan, as opposed to a bank loan, also include:

1. The parents' ability to set an interest rate far lower than any interest rate available through a bank. While the Internal Revenue Service regulations require that the interest rate of the loan equal a minimum rate set by the IRS each month, the current annual rate is just 2.19% for loans with a duration of more than nine years and significantly lower for shorter loans. If the parents desire, they can charge an interest rate greater than minimum rate but lower than current bank savings rates, increasing the parent’s benefit and still give a benefit to the child.
2. The parents give the child the opportunity to have access to an eventual inheritance much earlier, with much less risk. The parents can also assess the child's abilities to handle the money and perhaps modify the distribution provisions of their estate plan. 
3. In the event parents want to provide their child with an additional benefit, they can use their Annual Gift Tax Exemption to provide their children with the funds to reduce the principal of the loan, without the worry that the child will frivolously waste such gifts.

     To protect the client and avoid potential problems, it is important that clients document any intra-family loan's amount, term, interest rate, and repayment schedule in a formal written contract. This is important not only to ensure a return of the parent's money, but also for protecting the client against an IRS claim that the transaction was a gift, not a bona fide loan.  Courts have held that the existence of a written document evidencing the debt, the charging of a specific interest rate, the existence of a set repayment day, and proof of actual repayment of the loan are all criteria that favor the position of a transfer was a bona fide loan.

     Intra-family lending is a very useful technique for clients who want to provide gifts to their children, while retaining control of their own assets. As with all tax related strategies, clients should seek the advice of a qualified professional before engaging in an intra-family loan. Proper planning can provide benefits to both the borrower and the lender.

Gifting Strategies for Medical and Education Expenses

     As we touched on in our last blog, many strategies exist for using gifting as part of an estate plan. Today’s blog addresses some of the simpler planning opportunities available through gifting. In future blogs we will focus on the more sophisticated strategies.

     Tuesday’s blog discussed the Annual Gift Tax Exclusion, but it is important to note is that there is another, unlimited Gift Tax exclusion permitted for amounts paid by one individual in two circumstances:

1. On behalf of another individual directly to a qualifying educational organization as tuition for that other individual.
2. On behalf of another individual directly to a provider of medical care as payment for that medical care.

     A "qualifying educational organization" is one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where it regularly carries on educational activites. It can be a primary or secondary school, including a vocational high school, college, university, or a normal, technical, mechanical school and similar institutions. . The Internal Revenue Code (the "Code") permits an unlimited exclusion for tuition expenses of full-time or part-time students paid directly to the qualifying educational organization providing the education. The Code does not permit an unlimited exclusion for amounts paid for books, supplies, dormitory fees, board, or other similar expenses that do not constitute direct tuition costs.

     "Qualifying medical expenses" are limited to those expenses defined in Code §213(d), but include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primarily for and essential to medical care. In addition, the unlimited exclusion from the Gift Tax includes amounts paid for medical insurance on behalf of any individual. The unlimited exclusion from the Gift Tax does not apply to reimbursement for amounts paid for medical care by an individual. 

     While contributions to a qualified tuition program, such as a §529 plan do not qualify for the tuition exclusion above, they do enjoy treatment as a "present gift" that can qualify for the gift tax annual exclusion (currently $14,000 per year). The rules also allow the taxpayer electively to spread the contributions made in a single year over a five-year period. This means that grandparents can make a gift of $70,000 each ($14,000 times 5 years) to a §529 plan for a grandchild, for a total of $140,000 in one year, essentially "frontloading" a grandchild's education and allowing for a greater appreciation of the account. These gifts remove funds from the grandparents' estates, saving estate taxes on their deaths.  

     By using these gifting strategies, individuals can help their loved ones currently and reduce possible future estate taxation. Next week we will start discussing some of the sophisticated strategies used to increase the benefits of lifetime gifting in estate tax planning. 

Understanding the Estate and Gift Taxes

     One of the most misunderstood areas of estate planning involves the impact of Federal Estate and Gift Taxes. While most people understand they pay Federal Estate Tax on inherited assets and Federal Gift Tax on gifts made, few people truly understand what creates liability for these taxes and who is responsible for paying them.

     The first point to understand is that Federal Gift and Estate taxes are integrated into a single transfer tax under a unified rate schedule and with a unified credit that imposes a single tax on transfers during life and at death. The Internal Revenue Service group gifts and inherited assets together for purposes of determining total tax owed and the amount of assets excludable before payment of either Federal Gift or Estate taxes

     Let us begin with the Estate Tax. The estate of a deceased individual pays Estate Tax on the assets transferred to non-spouses at the individual's death. The estate tax rate is a sliding scale that tops out at 40%.  The Tax Code includes an Exclusion, which currently allows an estate to transfer $5,430,000.00 before incurring any Estate Tax liability. In addition to this large Exclusion, the Tax Code provides that any assets transferred to a surviving spouse are exempt from tax liability. In addition, any portion of the Exclusion that the estate of the first to die of a married couple does not use can be used by the surviving spouse's estate at his or her death. This ability, commonly known as Portability, means that a married couple will need to transfer nearly $11,000,000.00 at death before paying any Estate Tax. The Tax Code ties the Exclusion amount to the cost of living and therefore each year the Exclusion grows allowing ever-greater tax-free transfers.

     A person can choose to make gifts during lifetime instead of making bequests at death, making Gift Tax an important consideration. The person making the gift is liable for paying the Gift tax, if any is due. As indicated above, Gift and Estate taxes are integrated into a single transfer tax, so that the exclusion from tax becomes a "lifetime exclusion" rather than an exclusion at death. Any exclusion used during lifetime against Gift taxes will reduce the exclusion available against Estate taxes. 

     As noted above, we offset any Gift Tax against the Lifetime Exclusion before any tax becomes due. There is also another exclusion against Gift Tax--the "Annual Exclusion. A The Annual Exclusion on Gift Taxes allows any person to give up to $14,000 to any number of people, each year without creating any Gift tax liability. This means that a husband and wife together can give the each of their three children and their spouses $28,000 each year, reducing the parents' taxable estate by $168,000 each year without paying any tax on those transfers, and without using the Lifetime Exclusion. If our couple wanted to give their children additional amounts in a year, every dollar over $14,000 per beneficiary then reduces the parent’s Lifetime Exclusion.

     As an example, if the parents want to make a $200,000 gift to each of their three children so that the children can purchase a home, the parents can give a total of $28,000 to each child and $28,000 to each child’s spouse tax-free using the Annual Exclusion. The remaining $432,000 in gifts to the children and their spouses will reduce each of the parent's Lifetime Exclusion by $216,000 and reduce their remaining Estate Tax Exclusion by the same amount.

     In estate planning, we employ strategies that can increase the benefit of each of these Exclusions for people able to make substantial gifts. We will discuss some of these in our next blogs. 

Year End Charitable Gifting Strategies

As we discussed last week, many of our clients use this time of year to make annual gifts to family members. A number of those clients also plan their charitable gifting for the end of the year to take advantage of the deduction that such gifts provide against income tax liability. Some of our clients make direct cash gifts to their chosen charities, while others satisfy their charitable inclinations with gifts of property, such as artwork, real estate, or stock. These gifts allow them to deduct the charitable contributions, up to 50%, 30%, or 20% of their adjusted gross income, depending on the type of property contributed and the type of donee. Depending on the client’s financial situation, more advanced gifting techniques can provide greater benefit to both the client and the charity.

One of our clients, who will likely have some estate tax liability, uses Charitable Remainder Trusts (CRT) to maximize the value of her charitable gifts. The CRT stipulates that the client receives an annual payout of a percentage of the value of the trust during her lifetime, with charities receiving the remainder of the trust assets at her death. In addition to satisfying her charitable intentions over the long-term, she reduces her potential estate tax liability, obtains an income stream for her lifetime, and is eligible for an income tax deduction equal to the present value of the remainder interest, determined by using IRS tables. In her case, at age 70, a $1,000,000 transfer to a CRT with a 6% annual payout provided her with $60,000 of annual income for life, and give her a $466,370 charitable deduction.

Another client, who does not need additional current income, chose to take the opposite path and fund a Charitable LeadTrust (CLT). A CLT provides charities with an annual income stream for a period of time, with the remainder interest going to other beneficiaries. In this case, the client just sold a business, had a significant gain, and wanted a tax deduction in the year of sale. We set up the CLT to provide a 6% payout to charities for twenty years. At the end of twenty years, the remaining balance of the trust will be held for the benefit of his three children. This allowed our client to take an immediate charitable deduction of $2,124,000. In order to take the deduction in the year the CLT is funded, the taxpayer must report the income earned by the trust over the next 20 years, which our client was comfortable with because his income in future years would be much less than the current year. As with the CRT and additional benefit of a properly structured CLT is a reduction in the value of the client’s future estate tax liability.

Not all techniques require a long-term trust to facilitate gifting. One of our clients, knowing he was selling his business, sought advice regarding the best way to donate a portion of the proceeds to his favorite charities. To maximize funds received by the charities, we recommended that he donate a portion of the stock to a charitable trust set up for those charities. The trust then joined in the sale, received a portion of the proceeds tax-free, and distributed those proceeds to the charities. By contributing the stock first to the charitable trust and then having the charitable trust join in the sale, the charitable trust received the full amount of the proceeds without liability for income taxes. If the client had sold the stock first, he would have been liable for capital gains tax and there would have been fewer dollars available for the charitable contribution.

Finally, for those clients receiving distributions from an IRA, 2013 provides a unique opportunity. The tax rules provide that if a donor is at least 70 1/2 years of age, he or she can have the IRA distribute up to $100,000 per year directly to a charity and treat it as excludable from income. One of our clients, with a large IRA but little other available assets, has been using direct distributions from an IRA to charities for the last few years. This technique allows her to satisfy her chartable inclinations and reduce her own potential income tax liability. Unfortunately, due to a change in the law, 2013 is the last year this option is available.

There are a number of other creative ways to fund a client's charitable desires, provide them with income tax deductions, and limit liability for future estate taxes, but these techniques require proper planning. If any of your clients are interested in charitable gifting options for this year, they should consult with their advisors soon in order to provide sufficient time to implement strategies that maximize their charitable contributions.

Alan Ferrara and Matt Ferrara

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

Annual Gifts and Intra-family Lending

     In June we discussed the subject of intra-family loans, including the very low Applicable Federal Rate (AFR) for interest on such loans, with regards to parents who want to pass wealth to their children without giving up any of their own assets. Parents can also use a similar technique to pass wealth in the form of appreciable assets to a child who might otherwise squander gifts of cash. By tying annual gifts to the repayment of an intra-family loan, clients are able to assist spendthrift children while also not appreciably depleting their own assets.

     Currently a person can give $14,000 tax-free to any other individual every year. This means that a married couple can give $28,000 to their child and $28,000 to that child's spouse for a total gift of $56,000 each year. By combining intra-family loans and a plan of annual gifting it is possible for clients to loan their child money to purchase a new home, or other long-term asset, and use the annual gift to pay down the balance of the loan.

     For example, a client can loan their son $150,000 to purchase a new home (making sure to do so using a mortgage and the AFR for a three-year loan). At the end of each year of the loan, the clients write their son and daughter-in-law a check for the annual payment including interest and the son and daughter-in-law write a check back to the parents for the same amount. After the client’s check clears in the son’s account, the client cashes the son’s check, and the loan is paid for the year. The son and daughter-in-law get a home and the client gets to make a gift to their son without worrying that the gift will go to waste.

     In addition to documenting the loan, charging interest, and having a mortgage on the property, it is important when using this technique for the client to make an actual gift and for the child to write a check for the annual payment. Failing to do so creates the possibility that the IRS could determine that the child has taxable “Forgiveness of Debt Income” that can impact their income tax filing. As with any lifetime gift planning, it is important for clients to seek the advice of experienced professionals in order to minimize the chances of such unforeseen consequence.

Matt Ferrara