Gift tax now or estate tax later.

• Author: Robbins, Valerie C.
• Position: Brief Article

While no one enjoys paying estate and gift taxes, it is often inevitable. A question frequently faced by wealthy individuals is whether it is better to make gifts now and pay the gift tax, or let the heirs inherit and pay estate tax. It may come as a surprise that, in many situations, paying gift taxes now can save a bundle of estate taxes later. The savings is a true savings that, given even minimum investment returns, grows greater with time.

Under the uniform transfer tax, the rate of tax is the same for gifts made during lifetime as for assets left in the estate on death. However, paying gift taxes during lifetime has two major advantages. First, the asset gifted (and any future appreciation) is out of the estate. Second, the value of the gift tax paid is out of the estate if the donor lives beyond three years. Essentially, it is like getting a deduction for gift taxes paid during life.

Example: S's net worth/potential taxable estate is $9,000,000. She has already made gifts to her daughter (D) using her full $600,000 uniform transfer tax exemption, but has made no other gifts. S wants to give D a gift of $3,000,000 now, leaving her remaining estate to D at death. Assuming S lives more than three years after making the gift, the chart below compares making the gift now with leaving the entire $9,000,000 to D on S's death.

For simplicity, all calculations ignore any exclusions for annual gifts of $10,000 or less. A comparison of the same estate 12 years later (having doubled in size) is also shown to illustrate how dramatically this technique can increase the amount of wealth passed on to heirs.

S is able to leave $785,400 more to D by making the gift and paying the gift tax now. After 12 years, that difference has grown to $2,085,600. This makes lifetime gifting an extremely attractive tool.

Before embarking on a strategy of substantial...