Do your givin’ while your livin’ so your know’n where its goin’. Unknown Poet and Estate Planner
Many of my clients share with me their pleasure in seeing their family use and enjoy gifts made by them. Whether it is paying for a nice dinner out with the family (remember those days?), a vacation adventure with the grandkids, or even paying some of a grandchild’s staggering educational costs, my clients generally feel that making such significant lifetime gifts are a good use of hard-earned assets. For my part, I am glad to remind them of the tax planning benefits of making such lifetime gifts. In last month’s update, I provided a brief overview of the policy position of Biden and Trump and how those positions would impact estate planning. Ahead of the tax law changes I believe to be on the horizon, this month’s update provides a brief summary of “annual exclusion gifts.”
The Use of Annual Exclusion Gifting, Generally
Federal Tax Law: Under current federal law, a taxpayer can transfer assets at death equal to $11,580,000 before paying federal estate taxes. Likewise, a taxpayer can make lifetime gifts of up to $11,580,000 before paying federal gift taxes. These exemption amounts are tied together through a “unified credit,” such that lifetime gifts that reduce a taxpayer’s federal gift tax exemption (called a “taxable gift”) also reduce a taxpayer’s federal estate tax exemption. However, if a taxpayer makes total gifts of less than a specific amount in a calendar year to any one individual (such amount called the “annual exclusion amount,”) such gift(s) would not be considered a “taxable gift.” For 2020, the annual exclusion amount is $15,000. Married individuals can therefore make gifts totaling $30,000 without such gifts being characterized as “taxable gifts.”
Minnesota Tax Law. Minnesota imposes a state-level estate tax on Minnesota residents and the families of non-residents owning business or real estate assets located in Minnesota. Minnesota imposes no state-level gift tax. However, any gifts characterized as “taxable gifts” and made by a Minnesota resident within three years of his or her death will be characterized as owned by the Minnesota resident and thereby subject to Minnesota estate taxes. It is critical to note, however, that since an annual exclusion gift is not considered a “taxable gift,” annual exclusion gifts made by a Minnesota resident within three years of his or her death will not be subject to Minnesota estate taxes.
Three Common Annual Exclusion Gifting Strategies
Minnesota taxpayers might apply the annual exclusion rule by implementing one (or more) of three gifting strategies:
Outright Gifts. First, Minnesota taxpayers could make gifts of cash or other assets directly to family members. By making annual exclusion gifts over a number of years or making annual exclusion gifts to many different family members all at once, a taxpayer could significantly reduce the family Minnesota estate tax exposure at death. Consider Julie and John Anderson, who are are willing and able in 2020 to give $30,000 to each of their four children, $30,000 to each of the four spouses of their children, and $30,000 to each of their four grandchildren. This year alone, Julie and John could give a total gift of $360,000 without risk that the gifted amounts would be subject to Minnesota estate taxes. The gift of $360,000 in 2020 would, under current Minnesota law, save the family approximately $57,600 in Minnesota estate taxes.
Gifts to 529 Plans. Second, Minnesota taxpayers could make gifts to college savings plans, also known as “529 Plans.” Unlike other types of investment accounts, estate tax rules permit the taxpayer making the gift to the 529 Plans to retain ownership of the account(s) without subjecting the assets to estate taxes at death. Also, unlike other types of annual exclusion gifts, a taxpayer can “superfund” a 529 Plan account by making a one-time gift to a 529 Plan account equal to five years’ worth of annual exemptions and consider the “super-funded” gift as being made ratably over those five years. Under current law, a taxpayer could transfer $75,000 to a 529 Plan. Of course, the taxpayer could not make any other annual exclusion gifts for the benefit of the designated 529 Plan beneficiary over the next five years.
Premium Payments on Trust-Owned Life Insurance. Third, a Minnesota taxpayer with a life insurance policy in place could create an irrevocable life insurance trust to characterize some (or all) of the life insurance premium payments as being an annual exclusion gift. While the death benefit on a life insurance policy is not generally not exempt from estate taxes at death, life insurance owned by an irrevocable trust is exempt from estate taxes. If the insured family member simply paid the premium payment directly to the life insurance company, she would be considered as making a taxable gift to the irrevocable trust owning the life insurance policy. However, through a creative planning strategy first developed following a 1968 tax court decision (no joke, called Crummey v. Commissioner), a Minnesota taxpayer can consider premium payments as an annual exclusion gift if the family follows the following three-part process:
- The insured must pay the policy premium amount (the gift) to the trustee of the irrevocable trust;
- The trustee then uses the cash gift to pay the premium on the life insurance; and
- The beneficiary (or beneficiaries) of the irrevocable trust are provided a notice to withdraw an amount equal to the cash gift to the trust. While the beneficiary does not actually have to withdraw the gift, the mere right to withdraw the cash gift allows for the taxpayer to characterize the premium payment as an annual exclusion gift.
Of course, these gifting strategies must also be appropriate from a cash flow and retirement planning perspective. Ahead of the tax law changes that I believe are on the horizon, the implementation of one or more of these relatively simple strategies could prove to be tremendously efficient for tax purposes. Perhaps more significantly, clients would enjoy the benefit of seeing children and grandchildren use and enjoy their accumulated wealth even during lifetime.