Tax Guide: Planning for Gifts
Universal Advisor, 2007 Issue No. 3

Pirates have long been linked to buried treasure, perhaps as a means of funding their retirements. However, only one pirate, William Kidd, is actually known to have buried treasure. Captain Kidd, as he is commonly known, buried treasure on Long Island before sailing to New York to keep the treasure from authorities. He hoped to use the treasure as part of negotiations to get a pardon (which, unfortunately for him, did not happen). Though lacking a strong historical basis, stories like Treasure Island helped popularize the image of pirates burying their treasure (which, of course, led to treasure maps that always seemed to be easily lost and found by others).

Year-End Tax Moves

As the year end approaches, estate and gift plans should be reviewed (or created), and gifts or transfers sensitive to annual limitations (the annual gift exclusion, for example) should be executed. Although the unified transfer tax system is made up of three distinct, but closely related, taxes — the estate tax, the gift tax, and the generation-skipping transfer tax (GST) — this guide only addresses gift tax strategies, which are an important part of reducing an individual’s taxable estate.

Annual Gift Exclusion and Lifetime Exemption

Taxpayers may give $12,000 annually to any individual without a gift tax being imposed. For married taxpayers, joint gifts of $24,000 to an individual can be made. (The gifts must be gifts of “present” interests, which generally may not restrict the donee’s current use or access to the gift.) This exclusion is available annually, but unused amounts do not carry forward. Individuals also are allowed a $1 million lifetime gift tax exemption for gifts that exceed the annual exclusion.

Family Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs)

Taxpayers may give interests in an FLP or FLLC that owns or conducts a family business to their children or other beneficiaries to accomplish succession or estate planning goals. Although regular gifts can transfer substantial value out of an estate, this technique can be particularly valuable when the value of the business is depressed, because a greater percentage of the company can be transferred for the same gift tax cost. It also should be considered when the business is likely to appreciate substantially in the future since the future increase in value will be removed from the taxpayer’s estate. Gifts of interests in closely held businesses are often split between December and January to use the annual gift tax exemption for both years and to determine the value of both gifts with a single valuation.

Grantor Retained Annuity Trusts (GRATs)

A GRAT is an effective tax-planning tool to transfer securities with above-average appreciation potential to your children. A GRAT is a trust that holds securities or other assets that are donated by the transferor. Over the life of the GRAT, the transferor receives annual payments. At the end of the GRAT’s term, the assets are distributed to designated beneficiaries. The GRAT enables the transfer to take place at a gift tax value equal to the present discounted value of the future gift. For assets that are appreciating rapidly, the gift tax cost will be lower than a direct transfer, and the transferor will receive an income stream for a specified number of years.

Charitable Remainder Trusts (CRATs or CRUTs)

CRATs or CRUTs are an effective tax planning tool to transfer securities to a charitable organization. A CRAT (the A stands for annuity) or CRUT (the U stands for Unitrust) are trusts that hold securities or other assets donated by the transferor. Over the life of the CRAT or CRUT, the transferor receives annual payments based on annuity principals (for a CRAT) or based on a percentage of the annual fair market value of the securities (for a CRUT). At the end of the CRAT or CRUT term, the securities are distributed to the one or more designated charitable organizations. The CRAT or CRUT enables the individual to claim a current charitable deduction for the future value of the gift.

Irrevocable Life Insurance Trust (ILITs)

Life insurance policies, whose proceeds are often a significant part of an estate, can be transferred to an ILIT to minimize future estate taxes. If properly structured, the transfers to the ILIT, including the initial gift of the policy and subsequent gifts to pay annual premiums, can qualify for the annual gift tax exclusion. To avoid the inclusion of the policy proceeds in the donor’s taxable estate, the donor must relinquish control over the policies, including the right to designate beneficiaries or adjust their share of benefits.

Crummey Trusts

Transfers to a “Crummey” trust (named for the benefactor of an early trust using this strategy) qualify for the $12,000 annual gift exclusion even though the trust places substantial restrictions on the beneficiary’s use of the gift. To qualify for the annual gift exclusion, the beneficiary must be given the right to withdraw funds from the trust for a reasonable period of time following the gift. Funds that are not withdrawn become part of the trust corpus, which will not be distributed until some future date. Crummey withdrawal powers are frequently used with life insurance trusts to preserve the availability of the annual gift tax exclusion but may be used in many other circumstances.

Transfers for Medical or Education Costs

Individuals are entitled to an unlimited exclusion for gifts made to pay for medical expenses or tuition expenses of another. The gifts must be made directly to the medical facility or educational organization to qualify. The unlimited exclusion is in addition to the allowable annual gift tax exclusion.

Education Funding — Section 529 Plans

We discussed credits and deductions available for education costs in the Individual Tax Planning section of this guide. However, for higher income taxpayers, the credits and deductions are fully or partially phased out and provide little or no benefit. One of the most popular vehicles for funding your child’s education costs is a Section 529 plan. Gifts to Section 529 plans are eligible for the annual gift tax exclusion. In addition, if the gift exceeds the allowable exclusion, the taxpayer can elect to spread the excess amount ratably over a five-year period. As a result, a gift of up to $144,000 can be made by a married couple to a child or grandchild without gift tax implications.