By FPA member Eric S. Toya, CFP®
Last Updated: May 3, 2010
Over the past decade and a half, estate and gift taxes have undergone significant changes. In just the past 13 years, the estate tax exemption amount has gone from $600,000 in 1997 to $3.5 million in 2009 to being completely repealed in 2010 and is scheduled to return to $1 million in 2011. Of course, many in the financial planning and legal community expect further changes to the estate tax laws before the end of the year.
Planning around a quickly moving target, as estate tax laws have been, is problematic (to put it mildly). Unfortunately for many families who may be subject to estate taxes, the confusion has resulted in a lack of planning. The solution for many has been to delay planning until the future of estate taxes is certain; a time which may never arrive.
This could be a costly oversight, as 2010 provides an opportunity to take advantage of current gift tax laws. In most years, top gift and estate tax rates are the same. As mentioned above, the year 2010 is an exception in that the estate tax has been repealed. During this year of no estate taxes, gift tax rates have been reduced to 35 percent. While that may not sound like a great deal, top estate and gift tax rates were 45 percent in 2009 and are scheduled to go back to 55 percent in 2011. There could be significant savings to paying gift taxes this year over estate taxes in the future.
Even setting the actual tax rates aside, there is a significant advantage to paying gift taxes over estate taxes. The key is that the gift tax is an exclusive tax, whereas the estate tax is an inclusive tax. What does this mean? This is better explained using an example.
To keep the math simple, we'll assume that the rate for both gift and estate tax is 50 percent. Let's also assume that you have used up your unified credit (this means that there is no exemption amount remaining), and your goal is to have $1 million go to an heir. If the transfer occurred at your death, it would require $2 million before estate tax, but only $1.5 million before the gift tax. The reason is that the entire value of the estate is taxed at 50 percent — $1 million would go to the beneficiary and $1 million to taxes. On the other hand, the gift tax is assessed only on the amount of the gift. This means that a $1 million gift would cost $500,000 in taxes.
Factor in the 35 percent gift tax rate for 2010, and this could be an even bigger advantage. Other advantages to gifting versus waiting until death to transfer property include:
- The appreciation on the monies after the gift is not part of the estate.
- The person giving assets may enjoy seeing beneficiaries enjoy use of the money or assets during their lifetime.
It is important to keep in mind that there are disadvantages to gifting as well. The disadvantages include:
- Loss of use of the money gifted.
- Loss of step up in cost basis.
Keep in mind that everyone's situation is different. The amount and nature of your assets, as well as your tax status and goals are all important considerations. You should seek the assistance of tax, legal and financial planning professionals before making any decisions.
FPA member Eric S. Toya, CFP®, is Vice President of Wealth Management for Trovena, LLC in Redondo Beach, Calif. Eric graduated from the University of Southern California with a BS in Finance and Accounting and is a current member of the FPA Los Angeles Chapter Board of Directors. Eric has been quoted in national publications, including the Wall Street Journal, Money Magazine and the Los Angeles Times.