By Daphne Stern, Esq.

In my previous articles, I discussed various issues relating to wills, trusts, and estate planning and taxation. In this week’s article, I will explore the role of lifetime gifting in minimizing estate taxes so as to preserve assets passing to one’s family.

Estate Taxes

As explained in my last article (“Estate Taxes: A Primer,” January 3), upon a person’s death, the federal government imposes an estate tax on his or her property. However, each individual is given a federal estate tax exclusion in the amount of $10 million, indexed for inflation. In 2020, the exclusion amount is $11.58 million. This means that unless a person has assets whose value exceeds the exclusion amount of $11.58 million, he or she will pay no federal estate taxes upon death.

Under federal law, a surviving spouse will be able to utilize the first-to-die spouse’s unused exclusion, often referred to as “portability.” This means that if one spouse dies without having used any of his or her exclusion, the second spouse has a hefty exclusion amount of over $23 million. There is also an unlimited marital deduction for estate tax purposes, which allows assets to pass free of estate tax to a surviving spouse on the first spouse’s death.

In addition to the federal estate taxes, the estate of a New York resident is subject to New York estate tax. This tax is imposed on all of the resident’s property except for real property and tangible personal property located outside of the state. New York currently has an exclusion amount of $5.85 million. There is an unlimited marital deduction for New York State purposes, but no portability is allowed as to a predeceased spouse’s unused exclusion amount.

The New York estate tax is a “cliff tax.” This means that if the value of the estate exceeds the exclusion amount by more than five percent, the estate loses the benefit of the exclusion and the entire estate is subject to estate tax, not just the amount in excess of the exclusion. This makes it even more important to plan your estate effectively.

Estate tax planning strategies focus primarily on minimizing your taxable estate and maximizing the use of available exclusions and deductions. This article will discuss the former: how to reduce the value of your taxable estate through lifetime gifting so that it falls below the level at which estate taxes are imposed.

Lifetime Gifting

In order to reduce your estate, the simplest course of action is to make gifts to your heirs during your lifetime and so reduce the property that will be subject to estate tax at death. Of course, if it were that simple, we would all transfer our assets to our children currently and avoid estate tax. The federal government has anticipated this and imposes a gift tax on lifetime transfers.

However, the $11.8 million estate tax exclusion discussed above is actually a “unified credit” against both estate and gift tax. This mean that the exclusion granted to each individual may be applied to gifts during lifetime and/or estate assets at death. Accordingly, each individual may gift $11.8 million of assets without having to pay gift taxes and so reduce his or her estate. A majority of Americans, either fortunately or unfortunately, will not have assets in excess of this $11.8 million exclusion amount, so gifts will be covered.

In addition, under the federal tax laws, an individual may make gifts to as many recipients as he or she chooses in an amount up to $15,000 annually, without being subject to gift taxes. The donor may make these so called “annual exclusion gifts” without using any of the $11.8 million exclusion amount.

Another gifting opportunity relates to gifts for tuition or medical expenses. Individuals may pay the tuition or medical bills of another person without being subject to gift tax as long as certain requirements are met. The amounts must be paid directly to the educational institution or medical provider and may not be paid on behalf of individuals for whom the donor has a legal obligation of support.

As you are reading this, some of you may be thinking, “What does this have to do with me? I don’t have 11 million dollars!” However, many middle-income individuals do have assets in excess of $5.85 million, and if you live in New York, you will be subject to New York estate taxes as discussed above. The value of a house, 401(k) or other retirement plan, life insurance, and securities can easily add up to this figure, and if you exceed the New York estate tax cliff by a small amount, your entire estate (not just the amount in excess of the exclusion) will be subject to New York estate taxes.

In addition, the $11.8 million federal unified credit exclusion amount is at a historical high. In all likelihood, this amount will be significantly reduced in the not too distant future by Congress or a new administration. Even if the government fails to take any action to reduce the exclusion amount, the current law “sunsets” in 2025 and the exclusion amount reverts to its previous level of $5.6 million (indexed for inflation) in 2026.

It is also important to note that when a person makes gifts, he or she also removes the future appreciation from his or her estate and in effect “transfers” it free of estate taxes. This may be a significant opportunity to give an asset with growth potential to children and so reduce one’s estate by the asset’s value and its appreciation. Of course, each client’s assets must be evaluated on a case-by-case basis, taking into account many factors, including the capital gain consequences of retaining or transferring the particular property.

If you want to start more modestly, consider making annual exclusion gifts of $15,000 per recipient per year. You and your spouse may each make such gifts. “Gift splitting” is also permitted, where one spouse makes a $30,000 gift and it is treated as if each spouse had transferred one half of the amount. There is no gift tax in New York at all. If you are planning to leave your entire estate to your descendants eventually, then annual gifting to children and grandchildren is a simple and effective way to reduce your estate.

Gifting beyond the annual exclusion amounts would be advisable in many instances, particularly for people with higher net worth. As I said, this high exclusion amount will most probably be reduced, so now is the time to avail yourself of the current planning opportunities. And given that New York law does not impose a gift tax at this time, such transfers may be beneficial, particularly if you are a New York resident.

Gifting may be structured in many ways. Gifts may be made outright to the individuals or to certain types of trusts. Trusts are useful vehicles for people who wish to make gifts but are concerned about the recipient’s ability to manage finances, or where the recipient may have creditor or divorce issues. Particularly for people with higher net worth in excess of $11.8 million, valuation of certain assets may be reduced through gifts of fractional interests. Certain discounts for minority shares or lack of marketability may be applied so that more assets are transferred at a lower value and, accordingly, use less of the individual’s $11.8 million exemption.

Each individual’s asset holdings and family situation must be carefully analyzed in order to develop a plan that minimizes estate taxes while at the same time accomplishes estate planning goals. In many instances, gifting can be an effective mechanism for transferring assets to the next generation and minimizing the taxes that must be paid. 

Disclaimer: The author’s articles are provided for informational and educational purposes only and do not constitute legal advice. Publication of this information is not intended to create, and receipt or review does not constitute, an attorney–client relationship between the reader and the author. The information contained therein may be changed or rendered incorrect by future legislation or judicial developments. Readers should not rely on it in structuring or analyzing individual matters, and no action should be taken based on the ideas presented in these articles. Legal advice should be sought in connection with any such matter.

Daphne Stern, Esq. is an attorney practicing in Woodmere. She specializes in the area of wills, trusts, estate planning, and estate administration. Daphne may be reached at 516-295-0962, or by email at dstern@daphnesternlaw.com.

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