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by Judy Dahl




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Gifts to beneficiaries or charities during your lifetime benefit those you love and organizations you care about, giving you satisfaction—and tax advantages.

Gifting shrinks your estate, which may mean lower estate taxes. Also, gifting keeps your assets from going through probate at your death. When you give to charity, you can realize significant income tax deductions.

Tax advantages

The estate tax rates for years 2010 through 2012 are based on the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (TRA 2010) that President Obama signed into law on Dec. 17, 2010.

This law will sunset on Dec. 31, 2012, meaning that on Jan. 1, 2013, the federal estate tax exemption and rate will default to the numbers that were in effect in 2001/2002.

In 2012, $5,120,000 of your estate is exempt from estate taxes and the top tax rate is 35%. The 2001/2002 levels exempt a significantly smaller amount of your estate-$1 million-from estate taxes. The remainder is taxed at 55%.

If you think even $1 million is out of your league, add the value of your house, your retirement accounts, and other savings and see how close you really are.

There's more:

  • Your state also may charge its own estate or inheritance taxes.
  • Your spouse is exempt from paying estate taxes on assets that you pass to him or her at your death.

Gifts to your heirs

You can give quite a bit of money or property to individuals without paying gift taxes.

  • There's a $5.12 million lifetime gift-tax exemption as of 2012.
  • You can give an additional amount, currently $13,000, to as many individuals as you want without paying gift taxes each year. These gifts are not part of the lifetime exemption.
  • You also can give away more than $13,000 each year to any individual if you make the gift directly to a medical provider or educational institution for that person's benefit.

If the value of property goes up after you've given it as a gift, you never pay taxes on that increase in value.

If you think an asset will appreciate in value, it may make sense to get it out of your estate. "If the value of property goes up after you've given it as a gift, you never pay taxes on that increase in value," says Alfred DeLeo, a partner at law firm Cox, Castle, and Nicholson in Los Angeles, Calif.

He adds, "If I give away securities worth $1,000 today, it counts as part of my $13,000 gift to that person this year. If the securities go up to $10,000, that $9,000 isn't relevant for my gift tax or estate tax liability."

If you give your heirs money from a Roth IRA, since you've already paid income taxes on the funds, your heirs won't have to. If the amounts they inherit are less than the estate-tax exemption, they won't pay those taxes either. 

Giving 401(k), traditional IRA, or other retirement accounts to your heirs is a different story. They could be forced to forfeit a large portion to estate and income taxes. Nonprofits pay no taxes on such bequests, so it might make sense to give more tax-advantaged assets to heirs and leave your retirement accounts to charities.

Gifts to charities

Besides 401(k)s, IRAs, or other retirement accounts, gifts in any amount to charities approved by the Internal Revenue Service (IRS) are exempt from gift and estate taxes. "Gifting is a wonderful idea if you're planning to leave assets to charities," says Bob Miller, director and administrator of the National Institute of Certified Estate Planners, Kokomo, Ind. "You can give property or investments through a charitable trust and take an immediate income tax deduction, while getting the satisfaction of having made a huge difference to that charity."

"You can give property or investments through a charitable trust and take an immediate income tax deduction."

Some trusts allow you to continue benefiting from the assets during your lifetime. "You might set up a charitable trust if, let's say, you own General Motors stock and you're living on the dividends—and you still need that income—but you want the Red Cross to have that stock when you die," DeLeo explains.

Here are the different types of charitable trusts:

  • Charitable remainder trust. You set up a trust and transfer assets to it, with a charity as the beneficiary. The charity manages the trust and you receive a portion of the income the assets generate during your lifetime, either as an annuity—or equal amount per year—or a percentage of the actual earnings. At your death or the end of a set period, the property goes to the charity.
  • Charitable lead trust. You place assets in a trust managed by a charity, which receives the income from the trust during your lifetime. At the end of your life, the assets go to your heirs. This is a less common arrangement, DeLeo notes, used if you don't need the income from certain assets but want your heirs to inherit them.
  • Pooled income fund. This arrangement is similar to a charitable remainder trust, but for smaller donors. A charity establishes and manages a trust, and multiple donors transfer assets to it. They receive income from the assets during their lives and the assets transfer to the charity upon their deaths.
  • Retained life estate. Some nonprofits accept gifts of real estate and allow you to reside on the property during your lifetime. You receive an income tax deduction in the year you gift the property.

Remember that charitable trusts are irrevocable, meaning you can't undo them once they're established. There also are legal fees involved in setting up trusts, so unless you have quite a large estate, charitable trusts may not make sense.

Plan carefully

Careful analysis of gift amounts, along with proper timing and adherence to IRS regulations, is essential.

  • Take care of yourself first. "Don't give away so much that you're unable to support yourself during retirement," cautions John McNulty, professor emeritus of law at the University of California, Berkeley.
  • Do it early. "There's a 'lookback' period of three years," notes Miller. "If you give gifts to anyone within three years of your death, the IRS can pull those amounts back into your taxable estate."

"Don't give away so much that you're unable to support yourself during retirement."

  • Be prepared to give up control of your assets. "Sometimes parents give money, property, or valuables to their kids, but they still want some say over what happens to those assets," Miller says. "They don't have any say—it's a gift. If the donee goes bankrupt, or through a divorce, those assets are exposed to it."
  • Work with expert advisers. "Make sure your attorneys, financial planners, and tax advisers do estate planning often and understand gifting arrangements thoroughly—not all do," says Miller. Ask for references and interview advisers before engaging them.

"Most people's goal is to pass their estates to the next generation, and possibly to charities they care about, and properly executed gifting is a good way to do so," Miller says.

Published September 29, 2012

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