Shifting income among family members.

• Author: DiTommaso, Elizabeth

Facts

Greg's mother, who is 67 years old, receives monthly income from Social Security and a retirement fund from her husband's last employer. To help out, Greg gives her an additional $250 per month. Greg and his wife also have children to whom he would like to make substantial gifts.

Issue

Is there a better way for Greg to take care of his mother and transfer some wealth to his children?

Analysis

A better way to accomplish Greg's goals requires the use of a trust and the willingness to set aside a substantial sum of money. Greg could set up a trust, contributing $40,000. The terms of the trust would call for the trustee to distribute all the trust income to his mother for as long as she lives. On her death, the corpus would be distributed to his children in equal shares.

If the trust is structured in this manner, his mother would receive a gift in the amount of the present value of the income stream for her life. This gift would qualify for the $10,000 per donee annual exclusion. The difference between the gift to his mother and the $40,000 represents the amount of the gift to his children. This would be a gift of a future interest, since they could not currently enjoy the use of their remainder. As such, it would not be eligible for the annual exclusion, but the gift tax could be offset by an unused portion of the unified credit.

Assuming the trust is funded May 1, 1991, a discount rate of 9.6% must be used in valuing the gifts to his children and mother. (The taxpayer must use a discount rate equal to 120% of the applicable federal midterm rate (compounded annually) for the month the transfer is made. The actual rate is then rounded to the nearest two-tenths of 1%.) The amount of the gift to Greg's children would be $13,046 ($40,000 transfer x remainder factor of 0.32614).

[TABULAR DATA OMITTED]

Greg's gift to his mother is $26,954 ($40,000 - $ 13,046). If Greg's wife elects to split the gift with Greg, the taxable portion of the gift to his mother would be $6,954 ($26,954 present value of gift - $20,000 annual gift tax exclusion). The gift to the children (that is, the present value of the remainder) would also be a taxable gift. The tax with respect to both these gifts can be offset by any unused unified credit.

Greg will enjoy an income tax benefit from this transfer. Assume that Greg has been earning 9% on the $40,000 while he had it invested in his name. This income, after deducting income tax on the earnings, was not sufficient to...