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The Advantages of Making Taxable Lifetime Gifts

February 24, 2013
by Jack Reynolds

Tax time is approaching and if you are looking for ways to reduce your long-term tax burden then you have come to the right place. With all due respect to Uncle Sam, when it comes to paying taxes what you keep is just as important as what you make. During tax time most people focus on what they can do to reduce their taxable income. This is a good start, but it is not innovative enough.

A more innovative way to minimize your tax burden is to plan ahead by making a taxable gift during your lifetime vs. through your estate. You might be thinking, “Jack, I already reached the maximum tax-free giving amount set by Congress, why would I possibly want to make a taxable gift?” First, the concept of paying gift taxes now to avoid paying more estate taxes later is pretty powerful, even if you have exceeded your tax-exempt gift amount. Second, if you make the gift through an irrevocable trust, then you get to keep the income during your lifetime (this is covered in more detail below).

This week’s article reveals the financial and cash flow benefits of making a taxable lifetime gift vs. estate gift. (Pssst… If you have not already done so, consider taking advantage of the enormous tax-free giving opportunity that was scheduled to be dramatically reduced at the end of 2012; and is still in effect. Please click on the title to read What High Impact Tax Planning Can You Do in September?)

Financial Benefits of Taxable Lifetime Gifts

Say for example that you have exceeded your lifetime gift exemption, and all further gifts will be taxed as lifetime gifts or estate transfers.
(For the sake of simplicity, I will ignore the favorable impact of your annual gift tax exclusion as it will only serve to make your lifetime gifts more attractive.)

Let us assume that you have budgeted $1.5 million to cover the gifted amount as well as the federal tax that will be paid upon the gift’s transfer. Let us also assume that gift and estate tax rates are both 45%. How much money will your beneficiary vs. Uncle Sam receive if you make the gift during your lifetime vs. as an estate transfer?

Lifetime Gift:

  • Beneficiary Receives:

  • Uncle Sam Receives:
$   465,300 (45% of $1,034,000)
  • Total Out of Pocket:
$1,499,300 (pretty close to your $1.5 million budget)

Estate Transfer:

  • Beneficiary Receives:
$   825,000
  • Uncle Sam Receives:
$   675,000 (45% of your $1.5 million budget)
  • Total Out of Pocket:

The arithmetic is pretty compelling: taxable lifetime gifts are hugely more tax efficient than taxable estate transfers. Given a budget of $1.5 million, your beneficiary will receive roughly 25% more money if you make the gift during your lifetime vs. through your estate. This is because with estate transfers, the donor’s estate has to pay an estate tax on the estate resources that are being used to pay estate taxes. This is essentially a tax-on-the-tax, a double whammy that is not present with lifetime gifts.

“But wait there is more” (to quote the Ginzu knife infomercial). Some states, and local jurisdictions in other countries, have their own estate or inheritance tax and do not have a lifetime gift tax. This provides further incentives for making taxable lifetime gifts. Furthermore, if the asset being transferred is one that may appreciate in value, (such as an investment in a prospering enterprise), then removing that taxable appreciation from your estate may offer yet another important tax benefit for making a lifetime gift now.

Cash Flow Benefits of Taxable Lifetime Gifts

Going back to the original question, “Jack, I already reached the maximum tax-free giving amount set by Congress, why would I possibly want to make a taxable gift?” Suppose that you are concerned about cash flow because you need the income from your assets to pay for living expenses. If so, then you may want to speak with your Private Investment Counselor, attorney and accountant about structuring an irrevocable trust. An irrevocable trust can provide you and your spouse with the lifetime income from the gift and your beneficiary with the principal upon your death. Additionally, only a portion of the trust will be a taxable gift, further improving the tax efficiency of making taxable lifetime gifts.

If you are not concerned about cash flow, then you might consider gifting the entire amount to receive the tax efficiencies and the added pleasure of watching your beneficiary enjoy your gift during your lifetime.

Have I convinced you that making a taxable lifetime gift now vs. through your estate will reduce your overall long-term tax bite? It would be terrific if you would be so kind as to leave a comment, question and/or share your thoughts about taxable giving. If you would prefer to address this matter with me directly, please ring me at 617.945.5157 or drop me an email.