Dear Client:
Here is your 2007 year-end tax planning recommendations from an estate and
gift tax perspective. In addition, I have included techniques for gifts to
your children and grandchildren doing so without incurring any gift tax. Many
of these techniques will also reduce your overall income tax burden.
Use of Gift Tax Exemptions to Reduce Estate and Gift Tax
The current federal estate tax exemption is $2 million, although this amount
will shrink to $1 million in 2011 unless Congress decides to increase it. An
important method of ensuring that your estate will not be subject to estate
tax is to make sufficient gifts during your lifetime so that at your death
your estate is smaller than the then-current exemption amount.
Your lifetime gifts are, however, subject to a gift tax that is imposed at
the same rate as the estate tax. This “unified” system is intended
to eliminate any tax advantage to making gifts. But certain types of lifetime
transfers are not subject to gift tax and the end of the year is a good time
to make these tax-free gifts.
Annual Gift Tax Exclusion
The most commonly used method for tax-free giving is the annual gift tax
exclusion, which allows you to annually make a gift of up to $12,000 to each
donee with no gift tax. There is no limit on the number of donees to whom
you can make such gifts — if you make identical gifts to 10 donees,
you can exclude up to $120,000 from tax. In addition, if you are married you
can double the amount of the exclusion to $24,000 per donee, because you and
your spouse can combine your exemptions in a single gift from either of you.
Your annual gift tax exclusion expires at the end of each year, so the year
end is the appropriate time to take advantage of it. If you want to make a
gift that exceeds the amount of the exclusion, you can effectively double the
exclusion by making one gift in December and the second in January. For example,
if you are married, you can make a tax-free gift of $48,000 to any individual
by making a gift of $24,000 in December and another $24,000 gift in January.
The annual exclusion is applied on a per-donee basis. As a result, you
can leverage the exclusion by making gifts to multiple members of the same
family. For example, you could make $12,000 gifts to each of your son, his
wife and his daughter, for a total of $36,000 in tax-free gifts. This tax-free
amount can be doubled to $72,000 if your spouse joins in the gifts.
Tuition Payment Exclusion
In addition to the annual gift tax exclusion, you are allowed to make
tax-free tuition payments for any individual. There is no limit on the amount
that can be excluded, except that the payment must be to a tax-exempt school
and for the purpose of education or training. The exclusion applies only to
tuition — payments for room and board, books, or related expenses are
not eligible. Because there is no limit on the amount of the gift, its timing
is less important than it is with the annual exclusion. Nevertheless, if you
have the choice of making either a tuition payment or an annual exclusion gift
for a particular beneficiary, it will usually be better to make the tuition
payment, because that will give you the option of making an annual exclusion
gift later in the year.
If the tuition payment is made on behalf of a dependent, and if your adjusted
gross income is $160,000 or less (for a joint return), then you may also be
entitled to an income tax deduction for the payment. This deduction expires
at the end of 2007, so be sure to let us know before then if you think that
you may qualify.
Section 529 College Savings Plans
Contributions to a section 529 college savings plan do not qualify for the
exclusion for tuition payments, but can take advantage of the $12,000 annual
gift tax exclusion. The contribution to the plan may also entitle you to a
state income tax deduction.
Distributions from a 529 plan can be used for a wide range of educational
expenses, including tuition, fees, books, supplies, and room and board. An
added advantage of a gift to a 529 plan is that the income earned on the plan
contributions is tax-free, as long as it is eventually used for educational
purposes. Thus, you can reduce your own income taxes by funding a 529 plan
with savings that would have been used for college anyway. And because you can
name yourself as the custodian of the account, you ensure that your beneficiary
uses the account for educational purposes.
A special rule allows you to use up to five annual gift tax exclusions
when funding a 529 college savings plan. You can fund a savings plan with up
to $60,000 (5 x $12,000) this year and then file an election with the IRS to
spread this gift over five years (2007 - 2011) for gift tax purposes. By using
five annual exclusions, the entire gift becomes tax-free.
Medical Payment Exclusion
The payment of a beneficiary's medical expenses is also excluded from the gift
tax, with no limitation on the amount excluded. To qualify for this exclusion,
the payment must be made directly to the provider, and it must be for medical
expenses that would qualify for an income tax deduction. You can also claim an
income tax deduction for the payment if it is made for your spouse or dependent.
The exclusion for medical payments includes the payment of medical
insurance. If you have a child or grandchild who is paying for his or her own
insurance, payment of their insurance premiums is an efficient means of making
a tax-free gift that does not consume the $12,000 annual exclusion.
Gifts in Trust
Despite the tax savings, you may be uneasy about making outright gifts to
your children or grandchildren, due to your loss of control over how they use
the gift. This concern can be addressed by making the gifts in trust, which
will allow you to determine when they receive the money and how it is to be used.
There are special requirements for ensuring that a gift in trust qualifies
for the $12,000 annual exclusion. Usually, the trust is drafted to provide
the beneficiary with sufficient control over the gift that it is considered
a present interest rather than one that vests in the future. Although this
presents a risk of the beneficiary withdrawing the gift from the trust, the
probability of your terminating any further gifts to the trust is usually
sufficient to prevent this. If you are interested in making a gift in trust,
we will be glad to explain how this can be done.
Charitable Gifts
The year end is a good time to review your charitable giving to ensure that
it is being done in the most tax-efficient manner. Charitable giving is a form
of estate planning, because a gift to charity will never be subject to estate or
gift tax. If you are planning to make a large gift before January 1, we should
review its impact on your 2007 income tax liability and whether it may make sense
to defer all or a portion of the gift to 2008. If the gift is of property and
will require an appraisal (usually required for gifts of property with a value
in excess of $5,000, other than publicly traded stock), we should start the
process as soon as possible so that the appraisal is available before year end.
This year presents a special one-time planning opportunity if you are at least
age 70½ and wish to make a charitable gift from your IRA. In 2007, you can
transfer up to $100,000 to charity directly from your IRA. The gift may be made
in lieu of, or in addition to, your annual minimum required distribution. Because
the gift passes directly to charity, it has the benefit of not increasing your
adjusted gross income (thereby lessening any alternative minimum tax liability)
and is not subject to the cutback on itemized deductions. If you are interested
in making such a gift, you should defer taking your 2007 minimum required
distribution until we have the opportunity to demonstrate the tax benefits of
such a gift. This special provision will not be available in 2008.
In conclusion, we hope that the information in this letter is useful in your
year-end gift planning. If you wish to take advantage of any of the planning
techniques that we have described, please feel free to call.
Very truly yours,
Theodore Kleinman, CPA
