Filed Under:Life Insurance, Life Planning Strategies

Why You Still Shouldn’t Gamble on Gift and Estate Taxes

Boaz Yiftach

Boaz Yiftach

After reading many tax articles lately in various publications and even just listening to non-tax experts like my next-door neighbor, I’ve found that not only do many people believe that timing the stock market is pinpoint achievable, they also view that extreme gambling with the ever-changing tax code is never risky.

For example, a hot topic in many tax articles these days is gift taxes, relative to the estate tax sunset coming near the end of this year.  As of January 1, 2013, the tax laws sunset to 2001 levels if not extended by Congress. This will result in the inheritance tax exclusion dropping back from $5 million per person to $1 million, with the tax rate increasing from 35% to a 55% top bracket. 

  • There’s a risk to gifting assets that may be needed by the giving client later in life, which becomes an issue for me on several levels.  Once assets are gifted the right of ownership or control does not necessarily remain in the giver’s hands, but is now controleed by the giftee or heir.  Furthermore, if assets are gifted without some form of trust protection from lawsuits, bankruptcies, etc., the assets of parents and family heirs could be lost forever, especially if possibly needed later in life for retirement, medical or emergency needs. Of course, there are various planning tools for creating trusts when considering gifting assets for these reasons. However, assuming the trust route is taken, you then have to consider trust income tax rates, which drastically progress to the higher brackets even at the $10,000 income level, rather than the normal individual tax rate brackets.   
  • Another concern involved with gifting property instead of allowing it to be inherited is the capital gains tax basis. Property that is gifted requires the tax basis for gain or loss to be carried over to the receiving party as their basis. If the property is inherited (meaning after death), the receiving party’s basis is usually the fair market value at the date of death. Based on those facts, it is usually more advantageous for heirs to receive assets after death rather than prior (such as a gift) since capital gains tax rates will also increase should the law sunset in 2013.  
  • Lastly we have issues of accounts like IRAs that have pre-tax money built up in a client’s estate.  In this situation, not only is the IRA part of the total taxable estate for inheritance tax purposes, but it’s also subject to ordinary income tax if gifted to another person. That could cost not only income tax but possibly inheritance tax if the law does sunset to $1 million (assuming the client has assets far greater than the exclusion).
  • If allowed to pass through the inheritance process, most IRAs are allowed to convert to an IRA-beneficiary account that doesn’t require all the income tax to be paid immediately as would be required through gifting the IRA to another person (excluding charitable gifts). Therefore, as advisors make sure you know exactly what you are recommending to clients because IRAs are a completely different animal in the gifting-versus-inheritance tax equation.    

    Hopefully, I’ve shed a little more light on the complexity of the gifting-versus-inheritance tax dilemma.  I apologize for not hitting on all areas of concern such as the generation skipping tax.     

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