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A small gift

Are lifetime gifts a better idea than making heirs for my estate plan?

by Jimmy Verner | Contributor
December 16, 2019

Should you give your estate away during your lifetime, or leave it to be distributed by will once you pass away? To make your decision, you should consider tax consequences, the effect of your gifting on family harmony and how rewarded you will feel from making the gift.

When it's time to think about what to do with your estate, you have a choice. You can make gifts of it in increments as the years go by, or you can leave it to pass by your will. Each approach has its pros and cons, mostly from a tax perspective. Let's take a look.

Tax law

There are three types of taxes that warrant consideration when you are deciding between giving away your estate as opposed to allowing it to pass by will. The first kind is the federal gift tax. The second is the federal estate tax. Finally, there are the inheritance taxes that a few states impose.

Federal gift tax

A graduation cap on top of a book

According to the IRS, the federal tax law allows you to give away $16,000 per person each year to whomever you want without incurring a tax. If you are married, your can each give away $16,000. There is no reduction in the amount you and your spouse can each give just because you are married.

If you give away more than $16,000 to one person in a year, then you must pay the federal gift tax on the amount you gave to that person over $16,000. The gift tax rate ranges from 18% of the excess to 40%. But you won't have to pay that tax right now. The amount given over $16,000 per person becomes a credit to your federal estate tax when you pass away.

Certain payments not considered gifts

Federal law defines certain types of payments to benefit others as not gifts at all. Thus, they do not incur tax consequences regardless of amount. The three primary types of these non-gifts are money paid to to educational organizations, for medical expenses and as political contributions.

Educational organizations

If a school - not just a college, it could be an elementary or high school - has a regular curriculum, faculty and body of students, payments you make directly to the school aren't counted as excess gifts provided they are used solely for tuition. For example, you could give your granddaughter $16,000 and then pay tuition for her of $20,000 without incurring gift tax consequences.

Medical expenses

Any payments you make over the $16,000 limit for medical expenses or medical insurance are not subject to the gift tax if they are the same kinds of expenses that would be deductible for federal income purposes. You must make the payments directly to the provider, institution or insurance company. Using the same granddaughter as an example, you could pay for her unreimbursed medical expenses without suffering gift tax consequences.

Political organizations

You may give to political organizations without regard to any gift tax limitations. These political organizations include parties, committees, associations, funds or other organizations that exist to fundraise.

Tax forms

Federal estate tax

For 2022, federal tax law includes an exemption from taxation of $12.06 million for an estate. In other words, if your estate is worth less than that amount, then there will be no estate tax. But there is a caveat. If you have previously given more than $16,000 to any person in a year, then the IRS will count the excess against your exemption.

For example, suppose you give $100,000 to your son. Of that amount $85,000 would be applied against the estate tax exemption of $12.06 million, reducing the exemption to $11.976 million. For this reason, the $12.06 million is sometimes called the “lifetime gift tax exemption.” If you use up your lifetime gift tax exemption, then you will have used up your estate tax exemption, so tax would be imposed at the 18% to 40% rate upon your death.

State inheritance or gift taxes

In addition to federal taxes, some states impose inheritance or gift taxes. The rules among these states vary on how much of the estate is exempt, what the tax rate is, and who must pay the tax. Those states include Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. If you live in one of those states, or if the person you are giving to lives in one of them, you should consult that state's law to learn about the inheritance tax in that state.

Can gifts avoid family strife?

If you are thinking about making gifts to family members who might be beneficiaries of your will, a factor to consider is whether making those gifts would help lead to family harmony. The most bitter family fights that arise are over a decedent's estate. These fights involve not only who should be in charge, but how much money various beneficiaries should receive and how personal property of sentimental value should be divided.

You can avoid some of these issues by making gifts to your family and others while you are still alive. For example, if you make gifts of money, you can ensure that everyone similarly situated receives the same amount, or if not, have the chance to explain why your giving was disproportionate. For example, if one of your loved ones is handicapped, you could gift money into a trust and let others know the reason for that gift. Finally, personal objects often either no longer exist or cannot be found upon death. By giving them away during your lifetime, you can make sure that the person you have selected actually receives the gift.

Emotional rewards to the giver

In addition to the pleasure one feels when making a gift to another, there are some practical aspects of making gifts. For example, suppose you give a college student $16,000 but he fritters it away on parties and a car that is subsequently repossessed. You know that he is not ready for gifts at this time, so a testamentary gift or trust might be the better way to take care of him.

Another situation can arise where you both give money to a grandchild and, for example, pay tuition to the child's school. If the student does well, you have spent your money wisely and can take pride in the grandchild's achievements. But if the child is lackadaisical in school, then perhaps now is not the time to be giving gifts.

Thinking gifts over

The pros and cons of gifting over leaving property by will come down to three things. First, unless you are wealthy to the extent that you have an estate worth $12.06 million, you will not encounter any gift or estate tax consequences whichever route you choose. Second, if you try gifting money instead of leaving it posthumously, you can exercise control over the amounts and timing of gifts should your recipients turn out to be irresponsible with money. Finally, if you make gifts, you can enjoy the emotional rewards of helping others and appreciating their achievements should they use your gifts in a responsible way. The choices are yours.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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