Many people know that giving away assets before your death can protect your heirs from paying estate taxes, which can be as high as 40%. But in some cases, gifting can actually lead to an unintended increase in taxes… particularly income tax! Due to recent changes in the federal estate tax law, it might make sense to hold off on gifting away assets until after death, which provides you additional security and flexibility.

Federal Estate Taxes

As of 2018, an individual can give away up to $5.6 million during their lifetime, or upon their death, without incurring federal estate taxes. This amount is commonly referred to as an individual’s “lifetime exclusion.” For married couples, the exclusion is doubled to $11.2 million, and these numbers will increase annually with inflation.

If a spouse dies before using up the entire $5.6 million personal exclusion, the surviving spouse can claim the remainder. This is known as “portability” and the exclusion can be claimed by filing an estate tax return, or IRS Form 706.

As an added benefit, in 2018 you can give away up to $15,000 to any individual without using any of your lifetime exclusion noted above. As an example, a married couple can gift $30,000 per year to each of their children or grandchildren and not use any of the exclusion. You can also pay for the medical expenses or tuition of others and not use any of your lifetime exclusion as long as the money goes directly to the medical provider or school.

Which gifts are not included for the calculation of federal estate tax?

1. Gifts below the annual exclusion.
2. Tuition or medical expenses paid directly to a school or medical provider, not the individual.
3. Gifts to your spouse.
4. Gifts to a political organization for its use. In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.

In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.

Source: IRS

State Estate Taxes

Some states also assess their own estate tax. In Washington State, taxes are incurred on estates larger than $2.193 million as of 2018, and this amount is also indexed for inflation. The tax rate ranges from 10% up to 20%, depending on the size of the estate. Gifts made during your lifetime are not taxed by Washington State.

Some Washington State residents have opted to switch their residence to avoid incurring estate taxes. Arizona and Montana are among the states that do not currently charge estate taxes, and Washington State residents may own property there or take other steps to establish residency in a effort to avoid state estate taxes. For estate tax purposes, residency is determined by a number of factors, including driving licenses, location of credit card payments, utility bills, auto registrations, and others.

On the other hand, Washington State residents don’t pay income taxes. The residency requirement for income taxes is determined by how many days you reside in each state.

Be Careful What You Gift

If you do reside in Washington and your estate is greater than the $2.193 million exempted from estate taxes, you may want to consider gifting to reduce your estate to below the threshold. Your decision will depend in part on your mix of assets, as different assets receive different tax treatment.

For starters, gifted assets retain their cost basis for tax purposes. So for shares of stock or other assets which have appreciated in value that are gifted while you are alive, the recipient of the gift may incur capital gains tax on the difference between the purchase price and the current fair market value, should they choose to sell it. That may cost more than the estate tax. By comparison, if those assets are inherited upon death, their basis will be recalculated to current values, which means the recipient may avoid many of the capital gain tax consequences when compared to the same gift made while you are still alive.

Similarly, you should also refrain from gifting depreciated securities or other assets which have lost value. Doing so would forfeit any capital loss which could be claimed on your tax return. It’s better to sell those depreciated assets, take advantage of the loss on your personal return, and gift the proceeds.

So what are some good options for gifting? The best choices are cash, CDs and other assets with no capital gains. You might also consider gifting assets which require active management. As you grow older, you may not want to be maintaining an investment property or a vacation home.

 

As you can see, estate gift and tax planning involves planning around many variables. Many estate plans we see include planning language to specifically address both state and federal taxes upon an individual’s death. As laws are continually changing, it’s important that your own estate plan be reviewed and updated periodically. If you have questions about your specific plan, please contact your estate attorney.

If you are in need of a recommendation for an estate planning attorney who can provide additional guidance for your specific planning needs, please contact your Paracle advisor. Also, if you’d like to discuss this topic further, please let us know. We’ll be happy to review the strategies discussed here in greater detail.

We’d like to thank Laura Zeman, of Zeman Law Group PLLC, who contributed to this article.

Disclaimer: This article has been provided for informational purposes only and should not be considered as investment advice or as a recommendation. This material provides general information only. Paracle does not offer legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, this notice is to inform you that any tax advice included in this communication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of avoiding any federal tax penalty or promoting, marketing, or recommending to another party any transaction or matter.

Paracle Advisors is an investment advisor registered with the Securities and Exchange Commission.