Lifetime Gifts or Bequests: Answering the Deceptively Complex Question

One of your primary estate planning goals may be to pass as much of your wealth to your family as possible. That means sheltering your estate from gift and estate taxes. One way to do so is to make gifts during your lifetime.

Current tax law may make that an enticing proposition, given the inflation-adjusted $12.92 million gift and estate tax exemption. However, making lifetime gifts isn’t right for everyone. Depending on your circumstances, there may be tax advantages to keeping assets in your estate and making bequests at death.

Tax consequences of gifts vs. bequests

The primary advantage of making lifetime gifts is that by removing assets from your estate, you shield future appreciation from estate tax. But there’s a tradeoff: The recipient receives a “carryover” tax basis — that is, he or she assumes your basis in the asset. If a gifted asset has a low basis relative to its fair market value (FMV), then a sale will trigger capital gains taxes on the difference.

An asset transferred at death, however, currently receives a “stepped-up basis” equal to its date-of-death FMV. That means the recipient can sell it with little or no capital gains tax liability. So, the question becomes, which strategy has the lower tax cost: transferring an asset by gift (now) or by bequest (later)? The answer depends on several factors, including the asset’s basis-to-FMV ratio, the likelihood that its value will continue appreciating, your current or potential future exposure to gift and estate taxes, and the recipient’s time horizon — that is, how long you expect the recipient to hold the asset after receiving it.

Estate tax law changes ahead

Determining the right time to transfer wealth can be difficult, because so much depends on what happens to the gift and estate tax regime in the future. (Indeed, without further legislation from Congress, the base gift and estate tax exemption amount will return to an inflation-adjusted $5 million in 2026.) The good news is that it may be possible to reduce the impact of this uncertainty with carefully designed trusts.

Let’s say you believe the gift and estate tax exemption will be reduced dramatically in the near future. To take advantage of the current exemption, you transfer appreciated assets to an irrevocable trust, avoiding gift tax and shielding future appreciation from estate tax. Your beneficiaries receive a carryover basis in the assets, and they’ll be subject to capital gains taxes when they sell them.

Now suppose that, when you die, the exemption amount hasn’t dropped, but instead has stayed the same or increased. To hedge against this possibility, the trust gives the trustee certain powers that, if exercised, cause the assets to be included in your estate. Your beneficiaries will then enjoy a stepped-up basis and the higher exemption shields all or most of the assets’ appreciation from estate taxes.

Work with us to monitor legislative developments and adjust your estate plan accordingly. We can suggest strategies for building flexibility into your plan to soften the blow of future tax changes.

HoganTaylor Estate Planning Services

HoganTaylor estate planning professionals leverage their tax and business advisory expertise to help individuals accomplish goals and minimize tax burden. If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Estate Planning services, please contact Dan Bomhoff, Estate Planning  Lead.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.