A Good Time to Give To Family and Charity
With various tax breaks scheduled to expire at year-end, would-be donors are scrambling to transfer assets.
EDITOR'S NOTE: This article was originally published in the December 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.
Call it the Great Giveaway. Anticipating that a slew of tax breaks will disappear next year, seniors are scrambling to make year-end gifts to family members and charity. And they're not just writing checks. Would-be donors are scouring their portfolios, safe deposit boxes and even the attic as they seek to transfer artwork, family business interests, real estate, stocks and other assets.
In addition to benefiting charities and family members, such year-end gifts can help donors reap once-in-a-lifetime benefits. Seniors can use today's generous lifetime gift- and estate-tax exemption, rack up charitable deductions, avoid capital-gains taxes, and transfer future growth out of their taxable estates. Another boon for gift givers that won't be around forever: rock-bottom interest rates, which can help seniors transfer more assets while minimizing tax consequences. "There's a really strong case" for making sizable gifts today, says Katherine Dean, managing director of wealth planning at Wells Fargo. "We may never see a time like this again."
This gift-giving scramble comes in advance of a tax-law shakeup that some policy prognosticators call "taxmageddon." The federal exemption of $5.12 million ($10.24 million for couples) for gift and estate taxes is scheduled to revert to $1 million in 2013, while the estate-tax rate is set to rise to 55%, from 35%. With the Bush-era tax cuts set to expire, the highest rates on ordinary income and long-term capital gains are scheduled to climb higher. And proposals are circulating that would limit deductions, including charitable deductions, for high-income taxpayers and reduce the benefits of some popular wealth-transfer vehicles, such as grantor retained annuity trusts.
To be sure, seniors overly eager to seize a big tax break risk giving away too much and running short of money in retirement. Individual circumstances, such as income fluctuations, can alter the cost-benefit calculus for making gifts in 2012. And although Kiplinger's predicts that Congress will continue the current gift- and estate-tax rates and exemptions, at least for 2013, future changes are hardly written in stone. "Nobody really knows what Congress is going to do," says Rande Spiegelman, vice-president for financial planning at the Schwab Center for Financial Research. "It puts everybody in a bind."
Despite all the question marks, many advisers believe the advantages of making gifts before year-end generally outweigh the risks. And many donors seem to agree. "Clearly, there's a rush" to talk with lawyers and draft gifting plans, says William Zatorski, partner in the Private Company Services practice at PricewaterhouseCoopers. At donor-advised fund provider Fidelity Charitable, contributions in the first nine months of this year jumped 63% from the same period last year, to $1.2 billion.
Gifts to Charity
Got a house full of rugs or antiques that you're ready to part with? You might do yourself -- and charity -- a favor by finding a philanthropic way to unload them.
In the wake of the financial crisis, many more donors are looking to give such assets to charity. In 2011, for example, Fidelity Charitable saw contributions of complex assets grow 30% from a year earlier. One factor driving the trend: Donating such holdings won't diminish the cash and other liquid assets available to cover the donor's living expenses, says Bryan Clontz, president of Jacksonville, Fla.-based Charitable Solutions, which works with philanthropic organizations to help donors contribute illiquid assets.
Charities are also making it easier for donors to contribute everything from Warhols to Windsor chairs. The National Philanthropic Trust, a donor-advised fund provider, recently launched the Charitable Asset Trust, which specializes in accepting such complex assets as artwork, real estate and derivatives. It then sells these holdings, with the proceeds going into the donor's donor-advised fund. In these funds, donors get an immediate charitable deduction for contributions and can recommend how the money should be dispersed to specific charities over time.
Laura Robb of Winchester, Va., sees the ability to donate artwork and antiques as a bonus for the donor-advised fund she established in September through the National Philanthropic Trust. As an education consultant and author of books on teaching, Robb is focusing her charitable efforts on getting books and other teaching materials to schools serving communities with high poverty rates. "I've inherited a lot of things from both sides of the family, and I have some beautiful antiques that my children don't want," she says. "I'd like to use some of it in a different way."
For tax purposes, non-cash gifts over $5,000 typically must be independently appraised. Given the year-end gifting rush, many appraisers are booked up right now. But donors can still make the gift this year and get the appraisal before filing their 2012 return.
Another wrinkle involving donations of tangible personal property, such as artwork: The donor can generally only deduct the full fair market value of the asset if the charity uses the gift for its charitable purpose, such as a museum exhibiting a donated painting. If you instead give the painting to a social-service organization that then sells it, you can deduct the lesser of the amount you paid for it or its market value.
Seniors looking to sell a family business also have an opportunity to slash their tax bills and support charity. If you are thinking of selling your business but don't yet have a formal sale agreement, you might donate a fractional interest -- say, 2% or 3% -- to charity. Typically, an appraiser would sharply discount that fractional interest to reflect lack of control and marketability, resulting in a smaller charitable deduction for the donor. But if you instead get the appraisal after you sell the business, "almost always the appraisal will match the sales price," allowing for a bigger charitable deduction, Clontz says. The charity can cash in on the gift by selling its fractional interest to your business buyer.
If you have income-producing real estate or an investment portfolio that is expected to make big gains in years to come, consider placing the asset in a charitable lead trust. This vehicle gives a charity a stream of payments -- perhaps from real estate or investment income -- with the remaining trust assets going to your beneficiaries at the end of the trust term.
For gift- and estate-tax purposes, the value of that remainder depends partly on the tax code's Section 7520 rate at the time the trust is established. To the extent those assets grow faster than the 7520 rate, excess growth is passed to beneficiaries free of gift and estate tax. With the 7520 rate currently hovering around a historically low 1%, it's relatively easy for trust assets to beat that hurdle rate and transfer more wealth to the next generation tax free. The charitable lead trust is "a good strategy, and it's made great by the right interest rates," says Andrew Auchincloss, a director at Bernstein Global Wealth Management.
Given recent years' sizable market gains, gifts of appreciated stock make sense for many donors now. When you donate appreciated stock held for more than a year, you get a charitable deduction for the full market value and avoid paying capital-gains tax on sale of the shares. Don't donate securities trading at a loss, since you can use the capital loss to offset taxable gains. You can sell them yourself and then give the proceeds to charity.
Cash may be the only option for those making donations at the last minute. Eileen Heisman, president and chief executive officer of the National Philanthropic Trust, has this tip for procrastinators: If you're sending a check to charity on December 31, drop it in the U.S. mail, not FedEx or UPS. As long as it's postmarked by December 31, it will count as a 2012 gift. If you send a FedEx package on the last day of the year, your ability to recall the package means it's still in your control until the charity receives it -- and it will count as a 2013 gift.
Gifts to Family
You can make annual gifts of up to $13,000 to an unlimited number of individuals in 2012 without having to file a gift-tax return. But grandparents who don't want to hand a wad of cash to the grandkids can open a 529 college-savings plan for the benefit of a grandchild. They can contribute up to five years' worth of gifts, or $65,000 in 2012, to a 529 account without gift-tax consequences. If you’re the owner of the account, you can generally get your money back if you need it, whereas most gifting strategies require the donor to relinquish control of the asset.
The money grows tax deferred, and distributions are free of federal income tax when used to pay for qualified college costs. You also may be able to get a state tax deduction for 529 contributions. If you need to withdraw the money yourself -- say, to cover unexpected medical costs -- you'll owe federal income tax and a 10% penalty on the earnings. To compare state-sponsored 529 plans, go to SavingforCollege.com.
If you have a grandchild in school now, you can pay the tuition bill directly to the institution, whether it is a college or private elementary or secondary school. There's an unlimited gift-tax exclusion for such gifts, as well as for payments made directly to a health care provider for another person's medical care.
Record-high exemptions for the estate and gift tax make 2012 a good year to transfer assets to family members. From 2002 to 2010, the lifetime gift-tax exemption remained at $1 million, even as the estate-tax exemption rose. That meant you could give away in your lifetime up to $1 million free of gift taxes, above the annual exclusion. The estate- and gift-tax exemptions were "unified" at $5 million in 2011 and $5.12 million in 2012. (Each dollar you use of your gift-tax exemption reduces by a dollar the amount you can leave in your estate tax free.) That means you can transfer up to $5.12 million from your estate by year-end.
Many owners of smaller estates can benefit from the current tax law, especially if they want to move appreciating assets from their estates. But seniors thinking of giving shares of appreciated stock to the younger generation should step carefully, since they may cost the kids a tax break. Let's say you give your son shares of stock that you bought for $5 a share and are now worth $20 a share. Your $5 original cost, called the cost basis, transfers to your son, and he'll owe tax on the $15 gain if he sells the shares tomorrow. If you instead pass the shares to your son at your death, his cost basis will step up to the shares' market value on the date of your death, allowing him to immediately sell the stock without capital-gains tax consequences.
If you have an adult child or adult grandchild who qualifies for the 0% capital-gains rate (available to taxpayers in the 10% or 15% income-tax bracket), gifts of appreciated stock may make sense. And with the 0% capital-gains rate set to disappear in 2013, it may be "best to pull the trigger on that now," says Wells Fargo's Dean. For children holding investments, bear in mind that kids under age 18 and full-time students under 24 are subject to the "kiddie tax," meaning their investment income exceeding $1,900 will be taxed at the parent's higher income-tax rate.
An asset that is currently depressed in value but expected to increase significantly in the next few years -- a family business, for example -- may be an ideal candidate for a grantor retained annuity trust. Once you transfer assets to a GRAT, the trust pays you an annuity, typically based on the initial value of assets transferred. As with the charitable lead trust, the IRS assumes for purposes of calculating gift taxes that trust assets will grow at the 7520 rate at the time the trust is established. If your annuity payments over the trust's term equal the principal plus the 7520 rate, any appreciation of trust assets above that rate will pass to beneficiaries tax free at the end of the term. So today's low 7520 rate boosts the GRAT's potential to move future appreciation of assets out of your estate.
Many advisers recommend short two-year GRAT terms, since you must outlive the trust term for the assets to be transferred out of your estate. But the Obama administration has proposed a ten-year minimum term for GRATs. Given that attractive GRATs may be nixed, "it's something you might want to think about doing sooner rather than later," Spiegelman says.
Seniors who have previously made loans to kids or grandkids might consider a relatively simple year-end move: Forgive all or part of the loan. You can forgive up to $13,000 per person in 2012 without gift-tax consequences. Consult a lawyer to be sure the loan forgiveness is properly documented.
If you believe your estate will be subject to estate taxes, a life insurance policy may be another item to place on the giveaway pile. If you own a policy on your own life, death benefit proceeds are typically included in your taxable estate. If you transfer the policy to an irrevocable life insurance trust, it will be removed from your estate three years after the transfer -- allowing the insurance proceeds to go to heirs tax free. (The trust owns the policy, and you relinquish all control of it.)
Such trusts are often set up so that the insurance proceeds will cover the estate-tax bill. They're particularly suitable for estates that are low on easily tapped assets, says James Duggan, co-founder of law firm Duggan Bertsch, in Chicago, "where we need a source of liquidity to pay future taxes."