Planned Giving for Financial Advisors
Estate, Gift and Generation-Skipping Transfer Taxes
The advice that you give your client relies in part on the tax consequences of the investments, transfers, and estate plan that you and your client develop.
We are pleased to provide a synopsis of the income, gift and estate tax rules that apply to your client's charitable giving. For purposes of these examples, your client is also referred to as the "donor."
A Brief Summary of Estate, Gift and Generation-Skipping Transfer Tax Rules
Any time your client is prepared to transfer property to any individual, charity, corporation or other entity, whether during her lifetime or through her estate, she needs to consider whether federal and/or state "transfer tax" laws apply to that transfer.
Those laws include provisions for the payment of gift tax, estate tax, and generation-skipping transfer tax. There are deductions and exclusions that may exempt a lifetime transfer from gift tax or a testamentary gift from estate tax, but it's important to be familiar with the rules so that you can create the most tax-wise financial and estate plan.
Those rules may be summarized as follows:
When your client makes a transfer of property to an individual, either directly or indirectly during life, where full consideration is not received in return, it will be considered a "gift" for purposes of the gift tax rules.
As of 2014, every individual has a lifetime gift tax exemption amount of $5.34 million, which means that your client can make cumulative transfers during her lifetime up to that amount without incurring gift tax. In addition to the exemption, the following transfers will be excluded from gift tax each year:
- Gifts to an individual that qualify for and do not exceed the annual "gift tax exclusion" amount for the calendar year in which the gift was made. In 2013, that amount is $14,000.
- Tuition or medical expenses your client pays directly to the provider for someone else (these are known as the educational and medical gift tax exclusions).
- Gifts to your client's spouse. Gift of any size may be made if the spouse is a U.S. citizen; limitations on the amount excluded apply to gifts to non-citizen spouses.
- Gifts to qualified charities. These gifts avoid gift tax and are also deductible on your client's income tax return as noted above.
The recipient of gift property assumes the donor's cost basis for tax purposes. Thus, if your client bought a share of stock for $10 and its value is $100 on the date of the gift, the recipient will "assume" the donor's $10 cost basis. If the client sells the share for $100, she will recognize $90 of capital gain. There is no recognition of capital gain on gifts of appreciated property to charity.
The gift tax exemption amount ($5.34 million in 2014) is indexed for inflation each year. Gifts that do not qualify for exemption or exclusion will be taxed at a maximum rate of 40%.
Transfers made at your client's death through a will, beneficiary designation, joint-tenancy or otherwise will be subject to estate tax.
As of 2014, every individual has an estate tax exemption that equals $5.34 million minus any gift tax exemption used during life. For example,, if your client made a gift of $1 million outright or in trust to her children during her lifetime, and she were to die in 2013, she will have $4.25 million of exemption remaining to use for transfers at her death. Any amount transferred in excess of her remaining exemption will be subject to estate tax unless the transfer meets one of the following circumstances:
- There is an unlimited estate tax marital deduction for transfers made to a spouse who is a U.S. citizen (or structured properly for a non-U.S. citizen).
- There is an unlimited estate tax charitable deduction for transfers made to a qualified charity.
The estate tax exemption amount ($5.34 million in 2014) is indexed for inflation each year. Estate transfers that do not qualify for exemption or a marital or charitable deduction will be taxed at a maximum rate of 40%. Property distributed at death will receive a "stepped up" basis equal to the fair market value of the property as determined in the decedent's estate.
Depending on which state your client lives in, her estate may be also be subject to state estate taxes and/or inheritance taxes to the extent the estate distributions do not qualify for an estate tax exemption or deduction under the laws of that state.
In addition to gift and/or estate tax, transfers to grandchildren or others two or more generations younger than your client will incur generation-skipping transfer tax (GSTT), a separate tax that is applied in addition to gift tax (for lifetime transfers) or estate tax (for transfers at death). This tax is applied on top of gift tax or estate tax, as applicable, and can significantly reduce the value and advisability of a transfer to grandchildren.
The good news is that as of 2013, your client has a $5.25 million GSTT exemption, which allows for cumulative transfers to grandchildren during life or at death of $5.25 million. In addition, the following lifetime transfers to grandchildren will be excluded from GSTT:
- Gifts to a grandchild that qualify for and do not exceed the annual "gift tax exclusion" amount for the calendar year in which the gift was made. In 2013, that amount is $14,000.
- Tuition or medical expenses your client pays that qualify for the educational and/or medical GSTT tax exclusions.
The GSTT exemption amount ($5.34 million in 2014) is indexed for inflation each year. Transfers to grandchildren that do not qualify for exemption or exclusion will be taxed at a maximum rate of 40%.
As noted above, the income tax cost basis of assets held in your client's estate will be "stepped up" to the date of death values (or a value determined six months after the date of death, if lower than the date of death value). This means that a beneficiary who inherits an asset through your client's estate will take the date-of-death value as the basis, and when the beneficiary later sells the property, will recognize gain based only on the appreciation since the date of your client's death. This is in contrast to the "carry over" basis that applies to gift of appreciated property to individuals during life — the recipient of a gift of appreciated property will assume the donor's cost basis in the property and must pay capital gains based on that amount if the property is later sold.