Frequently Asked Questions about
Estate Planning, Wills, Trusts, and Probate

• May I avoid estate taxes by giving my property to my children or grandchildren while I’m still alive?

As we begin to consider ways to reduce estate taxes, one seemingly obvious solution is to simply give away property before death. This often is a good idea, but Congress has limited the benefit of “lifetime” gifts (that is, gifts you give during your lifetime) by imposing a “gift tax,” which works in coordination with the estate tax system. Thus, if you just give away a large sum of money or a valuable piece of property all at once, you will owe about the same tax as if you died and left the money or property to your recipient. There is a $1 million per person (for the year 2008) gift tax exclusion that applies to gifts made during your life, and then if not used up during life, to your estate. (Note that the gift tax exclusion is smaller than the $2 million death tax exclusion.) There are some other gift tax exclusions and exceptions, though.

First is the “$12,000 Annual Exclusion.” For those not averse to letting go of their hard-earned money and property during their lifetimes, excellent estate-planning results can be achieved by making small gifts each year. The first $12,000 of gifts made by one person to another each year (up from $11,000 for gifts made from 2002 through 2005, and $10,000 prior to 2002) are free of any estate or gift taxes. (This amount was indexed for inflation starting in 1998, but the indexed amount is rounded down to the nearest whole thousand – so it may be several more years before it jumps to $13,000.) There is no limit to the number of tax-free $12,000 per person per year gifts that can be made in your lifetime. A couple with three children thus could give up to $72,000 per year to the children ($12,000 from each donor to each child), or (if certain IRS rules regarding immediate withdrawal rights are followed) to an irrevocable trust for their benefit. Over a 10- or 20-year period, such gifts can build up into very substantial sums, and result in substantial estate-tax savings. The gifts need not be cash, and can include fractional interests in real property or shares in a corporation, partnership, or limited liability company.

There are other twists to the gift tax. For example, if you make large (over $12,000) gifts totaling more than $1 million during your lifetime, you will have to start paying gift taxes each year as you make the gifts. But the money you use to pay such lifetime gift taxes comes out of your bank account when the gifts are made – before you die. In contrast, estate taxes are imposed on the entire lump sum you leave, even though part of that sum will go to pay the estate tax itself. Lifetime gifts therefore can result in your donees’ getting more after-tax benefit – savings of 10 to 20 percent are the norm. Because of that difference, a general rule of thumb for wealthy donors is that incurring gift taxes now is more economical than incurring estate taxes later, even though the rates will usually be the same (45%).

(Note that certain gifts made less than three years before the giver's death may be included in the decedent’s estate anyway. For this reason, it is rarely advisable to delay gifts - especially gifts to trusts - that the donor is certain he is going to make during his lifetime, especially if the donor is elderly or in poor health.)

Another theoretical benefit – but also a potential disadvantage – of making lifetime gifts comes from the likely growth in the value of property. A $15 million estate today may be worth $30 million a decade from now. If you gave away $10 million today, you would pay a $4 million (plus small change) gift tax, but that net gift of $10 million could grow to $20 million in the recipient’s hands a decade from now. In contrast, if you left a bequest of $30 million, federal death taxes could take almost half, leaving your heirs with $16.5 million or less.

Any growth in the assets after you transfer them, however, normally would lead to income and capital gains taxes being paid by the transferee. (But it is possible to establish trusts upon which the donor, during his lifetime, pays income and capital gains taxes as they are incurred.) On the other hand, the positive effects of the compounding of earnings might in many cases outweigh even the negative effects of those taxes. Predicting the effects of taxes in various giving scenarios gift planning can be a daunting math exercise for accountants, actuaries and investment advisers, as well as a guessing game about what taxes and tax rates will apply in the future. And, of course, obtaining such advice will add to the expense of estate planning for relatively wealthy people. But, for such people, the final results are usually worth the extra work and expense.

“Generosity during life is a very different thing from generosity in the hour of death; one proceeds from genuine liberality, and benevolence; the other from pride or fear, or from the fact that you cannot take your money with you to the other world.” –Martial