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A Safety-First Approach to Year-End Gifting

As we approach the holidays and the end of the year, many people are getting ready to make gifts to their loved ones to help reduce their estates. This is a good time to engage in gifting strategies -- especially due to the uncertainty over the estate and gift tax rules for next year.

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» For the past two years, Americans have enjoyed a relatively favorable estate and gift tax regime. We will go back to a very unfavorable set of rules on January 13, 2013 unless Congress takes action and the President goes along.

Current Rules:

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• For estates of individuals who die in 2012, the federal estate tax exemption is $5.12 million, and so is the lifetime federal gift tax exemption. • The estate tax rate on the taxable value of an estate in excess of the exemption is a flat 35 percent, and so is the gift tax rate on lifetime gifts in excess of the exemption.

Rules Scheduled for Next Year:

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• If Congress does nothing on the estate and gift tax front, we will go back to the regime that was in effect before the Bush tax cuts were enacted. • That would mean a paltry $1 million unified estate and gift tax exemption and a maximum estate and gift tax rate of 55 percent. In addition, the valuable "portable exemption" privilege for surviving spouses would become history.

The upcoming election will affect what eventually happens. But for now, at least this much appears clear: You should still be able to rely on the annual gift tax exclusion to shelter lifetime transfers to family members and loved ones.

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The annual gift tax exclusion hasn't been affected by other tax law modifications over the last decade and that isn't expected to change. By systematically giving gifts that qualify for the exclusion, you can gradually reduce the size of your taxable estate over time -- no matter what Congress does or doesn't do.

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If you're interested in year-end gifts, don't wait until the very last minute. If a gift is made by check, it should be delivered and deposited by the recipient by December 31 to qualify for the 2012 annual exclusion. (However, the check can be paid by your bank in 2013.

Here's the basic premise. Under the annual gift tax exclusion, you can give gifts of cash or property to an unlimited number of recipients up to a specified amount without any gift tax consequences.

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The annual threshold amount is indexed for inflation. It is $13,000 for transfers in 2012, but the IRS recently announced the exclusion will increase to $14,000 for 2013.

In other words, you can give a single recipient cash and/or property valued at up to $13,000 in December and another $14,000 in January completely free of gift tax. If you give gifts within these limits, you don't even have to file a gift tax return.

The annual exclusion is doubled for joint gifts made by a married couple. For instance, a couple could give a child $26,000 in December and another $28,000 in January with no gift tax due. However, you must file a gift tax return for these joint gifts.

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A Concerted Gift-Giving Program

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» Separate and apart from the lifetime gift tax exemption, you can methodically reduce your taxable estate by bestowing sizeable gifts on as many family members as you desire. Let's say that you and your spouse, who own $2 million in assets, have three adult children and seven grandchildren. You plan to begin a concerted gift-giving program in 2014.

For simplicity, we'll assume that you give $28,000 to each one of your offspring each year for the next five years. (This doesn't account for any future inflation adjustments in the gift tax exemption.) By the end of the five-year period, you will have reduced your joint estate by $1.4 million ($28,000 times 10 times 5), leaving you with $600,000 (plus your earnings in the interim).

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Of course, you won't always be giving cash to family members. Generally, the value of property for gift tax purposes is its fair market value.

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If you gift property such as stock that has appreciated in value, the recipient must use your basis (usually, the original cost) to compute the taxable gain if he or she subsequently sells the property.

Nevertheless, the gain will be taxed to the recipient who is likely in a lower tax bracket than you will be. Thus, gifting can result in overall income tax savings as well -- especially with the low rates in effect this year.

Both the maximum tax rate on long-term capital gains and ordinary income tax rates are scheduled to go up next year unless Congress acts.

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Alternatively, depending on your situation, you might arrange to sell property first and give the cash proceeds to another family member.

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This is not to say that you should abandon other more sophisticated techniques, including family limited partnerships (FLPs) and intentionally defective grantor trusts (IDGTs), which are designed to maximize the benefits of the $5.12 million exemption in 2012.

Consult with your professional tax advisers before the end of the year to determine the best course of action for your situation.

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