Financial Planning for December 2004

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Just a Friendly Reminder
It’s hard to believe, but we’ve come to the end of another year and what a year we have endured. What with the presidential campaigns and other political maneuvering this past year, it hardly seems fair that we are now about to remind you of other unpleasant stuff, but we often have to be the bearers of less than joyous news, so here we go.

Just like the income tax year-end, we are also coming to the year-end for gift and estate planning purposes. So what does that mean to you? Well, if you have a fairly sizable estate and have embarked on an annual gifting program, this is the last month of 2004 to make gifts to your heirs. For 2004, if you have the cash, you and your spouse can gift up to $11,000 each to whomever you wish. Generally, that would be your child, grandchildren and other lineal descendants, but you are not limited to just those folks. In fact, you don’t even have to give them a dime, but if it looks like your estate will eventually be taxable, making the annual gift that is not taxable is one way to "spend down" your estate.

A second very good way to reduce your estate is to make gifts to your heirs that, while taxable, still don’t require a payment of taxes. As long as your cumulative gifts do not exceed the amount of an estate sheltered by the unified credit, you are in good shape from a federal standpoint. Presently, you and your spouse can each shelter an estate of $1.5 million using the unified credit and this is scheduled to gradually increase until 2010 if the law doesn’t change before that.

Using this exemption, it is a good idea to begin to gift away so much of your estate as you can afford to let loose of before your death. In many cases, you can achieve a significant reduction in the face value of an asset by using a qualified business valuation specialist to value assets given away in the form of partnership interests. In general, you would place the assets to be gifted in a family limited partnership, you and your spouse would be the general partners and then you would gift limited partnership interests to the kids. Be careful to cross every T and dot every I. The IRS has recently been challenging family limited partnerships that don’t meet business purpose tests and, more concerning, arrangements where the donor retains control of the assets as general partner. This planning technique should be utilized only after consultation with your attorney and tax advisor.

Beyond the annual gift and using the unified credit, consider paying college tuition and/or medical bills directly for your heirs rather than giving them the money to pay the bills. When you make the payment directly to the provider, it is not considered a gift at all.

You can also establish an education IRA for as many beneficiaries as you like. Even though you can’t put more than $2,000 in for each beneficiary, the good news is that any number of people can make a deposit for your child, grandchildren, etc. as long as the total doesn’t exceed $2,000 in any one year. There are some income limitations, but chances are that someone in the line will be able to make all or part of the gift without losing eligibility to do so. When your child does incur qualified expenses, the education IRA and its earnings can be used to cover the expense with no tax on the earnings.

Do you own your own business? Put your child to work. If not in this last month, start a program in 2005. Depending on their age and your business structure, you may be able to avoid social security and Medicare taxes, use the earnings to establish retirement accounts for the child and even pay for their allowance with deductible dollars. Of course, if the child has taxable income after any deductions, he or she will have to pay taxes.

If you make a gift in trust to your child or other heir, make sure the trust provides for Crummey powers. In general, to qualify for the $11,000/$22,000 exclusion, the gift must be of a present interest. To get around this for contributions in trust, some trusts provide a limited withdrawal right to the beneficiary. The trustee then sends a letter to the beneficiary letting them know a gift has been made and that he or she has the right to take the money instead of keeping it in the trust. The beneficiary then waives the right of withdrawal and everyone but Uncle Sam is happy.

A word to the wise - not all such gifts bypass the generation skipping tax, so you may need to allocate some of your lifetime exclusion from generation skipping tax to the transactions. Also, make sure the trust allows you to make the full amount of the $11,000/$22,000 gift. Some older trusts may limit the gift based on the exclusion when the trust was established.

Be careful in gifting appreciated property. While this may get the property out of your estate, it goes to your heirs at its original basis. Upon sale, this could rack up a large capital gain tax, where the heirs would have received a step up in basis to fair market value on the property in your estate. Although there are some techniques to mitigate the effects of this tax law, giving property that has not yet appreciated, but likely will, is a better bet.

Don’t forget your favorite charity. If you plan on leaving money to a charity anyway, why not gift property to a trust that will either pay you an income for life or pay the charity income until your death. Depending on the type of trust, the charity or your heirs would receive the trust principal at that time. The present value of the gift would then become a charitable deduction on your return. That’s what we call having your cake and eating it too.

There are a number of other items that may be of assistance in minimizing estate and gift taxes for you, but space prevents full discussion. If you do have a sizable estate, contact us immediately to give us time to help you take maximum advantage of year-end opportunities.

Have a wonderful holiday season and prosperous New Year.


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