Estate Tax Repeal and Lifetime Gifting: The Impact on Your Estate Plan

by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
Updated January 14, 2009

In Everyone Should Have an Estate Plan we talked about the basics of estate planning. Next, we’ll explore some sophisticated strategies that may help those with more sizable estates minimize estate taxes. But first, let's get comfortable with two key concepts: estate tax repeal and lifetime gifting.

Estate tax repeal
Although the estate tax is set to expire in 2010, under current law it comes back in 2011 in all its pre-2001 glory (see table). Many of your estate planning decisions will depend on what you think Congress might do down the road.

Estate tax and gift tax: 2009–2011

	Estate tax		Gift tax
	Highest rate	Exemption	Highest rate	Exemption
2009	45%	$3,500,000	45%	$1,000,000
2010	0%	Repeal	35%	$1,000,000
2011	55%	$1,000,000	55%	$1,000,000

That’s anyone’s guess, of course. We could revert back to the old law, or permanent repeal could become a reality. Or, we could end up with something in the middle—higher limits for taxable estates. As frustrating as the uncertainty might be, the best you can do is plan based on what you know now. Remember, any guess about the future is still just a guess, and the law as it stands is still the law.

Lifetime gifting
Lifetime gifts are generally better than testamentary gifts when transferring wealth.

Think of it this way: Picture four quarters on the table in front of you. If you die with all four quarters and you’re in a 50% estate tax bracket, your heirs are left with two quarters and the federal government gets the other two. Instead, move two quarters aside representing a lifetime gift to your loved ones. Now, take 50% of your remaining two quarters, or one quarter, and move it to the other side of the table as the gift tax you would owe (assuming you’ve already exhausted your lifetime exemption of $1 million). Look—you’ve still got a quarter left!

Gifting provides a couple of added bonuses, as well. For one, any future appreciation on the gift is in the hands of the beneficiary and outside your estate. Plus, you get to participate in the enjoyment of the gift while you’re alive, instead of after it’s too late.

How gifting works
Currently, you can give up to $13,000 each to any number of persons in a single year without incurring a taxable gift ($26,000 for spouses "splitting" gifts). In addition, you can make unlimited payments directly to medical providers or educational institutions on behalf of others without incurring a taxable gift.

If you make a gift of more than $13,000 to any one person during the course of the year, you have to report the taxable gift on a Gift Tax Return (IRS Form 709). Spouses splitting gifts must also file Form 709, even when no taxable gift is incurred.

For taxable gifts, each donor has an aggregate lifetime exemption of $1 million before any out-of-pocket gift tax is due. In other words, you can give away a total of $1 million during your lifetime—over and above the annual exclusion and any payments you make directly to educational or medical providers on behalf of another—and still avoid gift tax.

The lucky recipient of the gift owes no gift tax or income tax, and doesn’t even have to report the gift unless it came from a foreign source.

Lifetime gifting and estate planning
Typically, it's a great strategy to take advantage of the annual $13,000 exclusion, make payments directly to medical and educational providers on behalf of loved ones, and preserve your $1 million lifetime exemption.

However, for those with large estates, it often makes sense to also make taxable lifetime gifts utilizing the $1 million lifetime exemption—or even beyond if your net worth is very high.

Most advanced wealth-transfer strategies, including some we'll discuss next, minimize gift taxes by taking advantage of the annual exclusion, the lifetime exemption, and valuation discounts available under the law (a valuation discount means the gift is worth less than its apparent value for gift tax purposes).

Finally, before moving on to more sophisticated gifting strategies, here are a couple of caveats:

Lifetime gifting can be a great strategy, as long as you leave yourself enough to live on. For the gift to count, it has to be irrevocable. You don’t want to give until it hurts, so be sure to plan carefully with the help of a professional.
If the estate tax is repealed in the future, you may regret having paid gift tax now in an effort to minimize your estate tax. Again, you have to do the best you can based on what you know now, within the context of your goals.

Important Disclosures

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA and/or attorney.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The strategies mentioned may not be suitable for everyone. Each investor needs to review strategy in light of his or her own particular situation.

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