LAWS AND ESTATES
Using the Annual Exclusion
This technique is often overlooked, but there are many ways to
use it as part of your client’s estate plan.
As described in my last colum n, the
annual exclusion has many benefits for someone developing his estate plan. In this article, we will
explore several ways your client can effectively use this tool
to make the most of his assets.
In running the estate-tax calculations used in this article, we
will assume an estate-tax rate of
45 percent, the current flat rate
for the federal estate tax, and a
15 percent capital-gains rate. Both
rates could change in 2011 and both
ignore any applicable state taxes.
Gift loans. Suppose the newly
married daughter of a married couple
needs $120,000 to help buy a business.
The maximum available annual exclusion gift is only $48,000 (i.e., gifting by
the parents to the daughter and son-in-law), leaving $72,000 that would have to
be used against the gift-tax exemption,
with the added cost of filing a federal gift
tax return.
Instead, your client could make an
annual exclusion gift of $48,000 to the
newlyweds and make a short-term loan
of $72,000 to them. In the next two
years, the client could send the newlyweds a note forgiving $48,000 and then
$24,000. Current short-term AFTR rates
for the note are around 2 percent. Moreover, because the loan is below $100,000,
the IRS’ attributed interest cost on an
“interest free” loan may be limited to the
borrower’s net investment income (Code
Section 7872(d)( 1)).
IRA funding. Parents or grandparents
can make annual exclusion gifts to minors who may qualify for the Roth IRA
and are in lower tax brackets, but do not
have the funds to make the contributions.
For example, consider having a grandparent match the earned income of a grandchild’s summer job to fund a Roth IRA.
Tuition and medical gifts. In addition
to the annual exclusion, tuition paid on
behalf of any individual for the education
or training of the donee or for the donee’s
medical care is not subject to a gift tax
(Code IRC Section 2503(e)). Therefore,
parents and grandparents should consider making tax-free gifts of tuition and
medical costs for family members, while
preserving their exemptions and annual
exclusions. Because there is no relationship requirement for tuition or medical
gifts, even nonrelatives can make the excluded payments (Treasury Regulation
25.2503-6(a)).
The payments should be made directly
to the qualifying medical or educational
provider. The tuition exception is lim-
ited to tuition costs and does not apply
to amounts paid for room, board, books
or supplies. The unlimited exclusion for
medical expenses is not permitted
for amounts that are reimbursed by
insurance.
Two related income-tax issues should be noted. First, unless the donee is a dependent of
the donor, the donor will not
be entitled to an income-tax deduction for payment of medical
expenses. Second, the amount of
the gift could constitute taxable
income to a parent who had the
obligation to provide that support.
The tuition payment offers
some interesting planning opportunities. In PLR 200602002 (see also PLR
199941013), the IRS agreed that a grandmother’s advance, nonrefundable payment of her six grandchildren’s tuition at
a private school for grades K- 12 were excluded from her gift tax pursuant to IRC
Section 2503(e). This ruling offers an opportunity for clients (especially those who
may die before the tuition comes due) to
reduce their taxable estate.
For example, assume the annual tuition for grades K- 12 was $20,000. Pre-payment for six grandchildren for 13
years of school would move $1,560,000
immediately out of the donor’s estate at a
current tax savings of $702,000.
529 Plans. Gifts may also be made to a
qualified state tuition program (often referred to as a 529 Plan) as prepaid tuition.
However, these gifts do not qualify for the
tuition gift exclusion and will instead be
covered by the annual exclusion or unified credit. The donor can elect to have
the gift treated as made over a five-year
