To Gift or Not To Gift . . . That is the Question

Many seniors want to share some of their wealth. The question becomes whether to make a gift while you’re living, or wait and let the assets be distributed by your estate.

Benefits of gifting while alive

One benefit to gifting is that it removes an appreciating asset from your estate. Assume that you, as the donor, own shares of stock that have consistently been increasing in value -- great as an investment, but not so great for potential estate tax. Making a gift of the stock removes it, and all future growth, from your estate. Additionally, current tax laws allow you to give annual gifts of up to $12,000 with no gift tax consequences.
There are, however, some downsides to making a gift. First, the donor normally has to give up any control of the asset for the gift to qualify for positive estate tax treatment. Perhaps more significant is the potential tax liability from gifting:

Usually, no tax is due on a gift to a spouse or to charity. Other gifts in excess of the annual ($12,000) exclusion amount may be taxable. However, a donor can use an available tax credit, currently $345,800, to exclude up to a million dollars of taxable gifts from gift tax.
The person who receives the gift owes no income tax until he or she sells the gift. For example, a parent gifts $50,000 in stocks to a child. Ten years later, the child sells the stock for $130,000 – a profit of $80,000. The entire $80,000 gain is likely to be taxable; but this would not be the case if the asset was given to the child after the parent’s death. (If the parent sells the stock and gives the child cash, the child will probably not have any income tax liability, but the parent will likely owe capital gains tax on the sale.)

Benefits of waiting for an estate distribution

If the estate distributes assets after the donor’s death, the recipient will receive favorable tax treatment. Using the example above, the amount of tax that the child owes from selling the stock is calculated on the basis of $130,000, rather than original value of $50,000. This reduces and might even eliminate the tax liability on the sale for the child. However, the parent’s (donor’s) estate must pay tax on the $130,000 -- a potential tax liability of 45 percent.

Which is the better approach?

The answer to which is better depends on the individual’s objectives. A word of caution is in order: in this, as in all complex financial areas, seeking the assistance of a qualified professional is highly recommended. If the primary goal is to reduce potential estate tax liability, giving the gift while the donor is living works best. If the goal is to reduce the recipient’s income tax liability, then giving cash or an estate distribution is probably best. This means that the donor will have an increased tax liability, but it also means that the donor gets to experience the pleasure of giving a gift while alive.

For more information, go to:

www.irs.gov/publications/p950/index.htmlfor the Internal Revenue Service (IRS) primer on estate and gift taxes
www.answers.com/topic/step-up-in-basis?cat=biz-finfor a description of the “step-up in basis” calculation for determining tax liability when selling assets that are received as inheritances