Gifting for High Net Worth clients

There have been a lot of changes in the estate tax laws in the last several years.  We now have an exemption amount of $11,180,000, and it is portable between spouses in most instances.  This combination of amount, and portability, has virtually eliminated true “estate tax planning” for the vast majority of individuals.

However, there remain individuals with high net worth, for whom “estate tax planning” remains very relevant.  While I most often try to focus my articles on estate planning and probate topics that are broadly applicable, every now and again its worth focusing on a topic that might have only limited applicability. Especially if an answer is not as obvious as one might think!  So today, let’s look at a significant gift of cash or other liquid assets.

For our example, lets assume the donor is John Doe, a widow with a high net worth, and both he and his spouse have previously fully utilized their exemptions. John is pretty flush with cash, cash equivalents, or assets that could be liquidated without significant gain. John would like to transfer $10,000,000 to his child or children and let’s assume further that his assets are such that that he will continue to live comfortably.

What will be the most tax efficient?  A lump sum cash gift right now (realizing it will incur gift tax) or a lump sum cash transfer at death (realizing it will incur estate tax)?  Or is there even a difference, considering the estate and gift tax rate is currently a unified 40%?

It may surprise you if you’ve not worked through the computations, but there IS a difference, and a pretty significant one at that.

As a lifetime gift, the $10,000,000 transfer would incur $4,000,000 of gift tax, so John’s gift will ‘cost’ him $14,000,000 ($10,000,000 to make the gift, $4,000,000 to pay the tax).

As a bequest under John’s Will, for the child or children to get the same $10,000,000, John needs to have $16,666,667 available in his estate, because $16,666,666 in his estate, after application of the 40% estate tax, will net the same $10,000,000 gift.

You had to go back and read that a second time, didn’t you? That’s a $2.6M difference in the assets required! So the bequest under the Will generates $2.6 million more in tax!!

Let’s look now at a slightly different scenario.  Instead of a $10,000,000 total or net gift, let’s assume John has a total of $10,000,000 of assets available to gift or pass to the children.  The children still come out significantly better by receiving a lifetime gift.

As a lifetime gift, the net gift that will result out of $10,000,000 is $7,142,857, and 40% tax on that $7.142 million would be $2,857,143, which totals our $10,000,000.

As a bequest under John’s Will, the $10,000,000 will incur $4,000,000 of estate tax, such that the net amount of the bequest is only $6,000,000.

Between these two options, the lifetime transfer puts $1,142,857 more in the children’s pockets!

Of course, one other reason to favor the lifetime gift, again where basis issues are not a concern, is that the lifetime gift removes the asset from the hands and estate of the donor, thus removing any future appreciation as well, which is important if he has already exhausted his exemption. REMEMBER, however, that the donor needs to survive for 3 years on the lifetime gift option to keep it from being pulled back in to his estate!