When it comes to giving away other people's money, it can be really easy for an advisor such as an attorney, accountant or financial planner to tell a client that using up his or her $5 million+ lifetime gift tax exemption before the end of 2012 will be a "slam dunk" or "no brainer." Why? Because on January 1, 2013, the lifetime gift tax exemption is scheduled to drop significantly from $5 million+ to $1 million and the gift tax rate is scheduled to jump from 35% to 55%. So why not just dive right in and take advantage of this $4 million, 20% differential? Well, with most things that seem like a "slam dunk" or "no brainer," it is always best to proceed with caution. I happen to agree with CPA and wealth management advisor Andrew Rice, who has written Why You Still Shouldn't Gamble on Gift and Estate Taxes for AdvisorOne.com. In this article, Mr. Rice points out that there should be "a comprehensive outlook advising clients on a far more complicated matter than just a 35% tax rate versus the 55% tax rate possibility in 2013." Here is a summary of six things that Mr. Rice says should be considered when thinking about using up your $5 million+ lifetime gift tax exemption before the end of 2012:
- Consult with a tax advisor. This will allow you to consider all of the possible income tax, gift tax, generation-skipping transfer tax and estate tax scenarios.
- Analyze future income taxation. Review taxation of the property that you would like to gift with regard to ordinary income vs. capital gains.
- Be aware of the possibility of a tax clawback. Per Mr. Rice's opinion, "the tax code does not clearly state that a client would keep the $5 million gift tax exclusion if the client dies once the inheritance and gift tax exclusion drops back to $1 million. Which means the $4 million previously gift taxed could still owe the full inheritance tax at death. Therefore, the overall situation would still result in tax being paid at death, regardless, at the combined possible rate of 55%." This concept is referred to a tax "clawback."
- You may gift away what you need later in life. What you give away now cannot easily be given back without additional gift tax, income tax and estate tax consequences.
- Be aware of carryover basis vs. inherited basis. Under current law, the recipient of a gift receives the giftor's income tax basis in the gifted property, while the recipient of most inherited property will receive a step up in the income tax basis to the date of death fair market value of the inherited property.
- Gifting assets in an IRA requires special consideration. Gifting assets in an IRA to an individual will result in immediate income taxes, but in most cases the majority of income taxes can be deferred if an IRA is inherited after the original account holder's death.
The bottom line - using up your $5 million+ lifetime exemption should not be taken lightly and should only be considered after discussing all of the pros and cons with your team of advisors, including your estate planning attorney, your tax advisor, and your financial advisor.