Deciding whether to make lifetime gifts or bequests at death can be a deceptively complex question

giving excess gifts and filing a gift tax return vs. bequestsPassing on as much of your fortune to your family as possible may be one of your primary estate planning objectives. Protecting your estate from gift and estate taxes entails doing that. Making gifts throughout your lifetime is one way to do this. Given the inflation-adjusted $12.92 million gift and estate tax exemption, current tax rules may make that an alluring proposal. Making lifetime gifts, however, is only appropriate for some. There may be tax benefits to preserving assets in your estate and leaving bequests at death, depending on your circumstances. So, gifts vs. bequests? Which is right for you?

Tax consequences of gifts vs. bequests

Making gifts during your lifetime has the main benefit of protecting future appreciation from estate tax. This is accomplished by eliminating assets from your estate. However, there is a downside: the recipient obtains a “carryover” tax basis, meaning they take on your asset’s basis. A sale of a gifted item will result in capital gains taxes on the difference if the basis is low compared to the fair market value (FMV).

However, at the moment, an asset transferred upon death is given a “stepped-up basis” equal to its FMV on the day of death. According to this, the recipient can sell it with little to no capital gains tax liability. Which approach—transferring an asset by gift (now) or by bequest (later)—has the lower tax cost? Multiple variables play a role in determining the answer, such as:

  • The basis-to-FMV ratio of the asset
  • The likelihood that its value will increase in the future
  • Your exposure to gift and estate taxes now and in the future
  • The recipient’s time horizon or how long you anticipate them to keep the asset after receiving it

Estate tax law changes ahead

Knowing when to transfer wealth can be challenging because so much depends on the future of the gift and estate tax system. The base gift and estate tax exemption threshold will revert to an inflation-adjusted $5 million in 2026, absent further legislation from Congress. With correctly crafted trusts, it may be feasible to lessen the effects of this uncertainty.

Let’s imagine the exemption for gift and estate taxes will soon decrease drastically. You transfer valued assets to an irrevocable trust to take advantage of the present exemption, avoiding gift tax and protecting future gains from estate tax. The assets go to your beneficiaries on a carryover basis. When they sell, they will be subject to capital gains taxes.

Imagine that the exemption amount has increased or remained unchanged after you pass away rather than decreased. The trust grants the trustee specific powers that, if used, would include the assets in your estate to protect against this risk. The increased exemption thus protects all or most of the asset appreciation from estate taxes. Your beneficiaries will benefit from a stepped-up basis.

Don’t hesitate to contact our RRBB advisors to monitor legislative changes and modify your estate plan as necessary. We can offer tactics for incorporating flexibility into your plan to lessen the impact of upcoming tax changes.

© 2023


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