GIFT PLANNING USING THE ANNUAL EXCLUSION AND VALUATION DISCOUNTS

Gift planning using the annual exclusion and valuation discounts is one of the simplest and most cost effective ways to minimize estate taxes. Under U.S. Gift Tax Law (specifically, Section 2503 of the Internal Revenue Code), every individual can make gifts of up to $10,000 per year (indexed for inflation starting in 1999), per recipient, without incurring a gift tax and without even triggering the requirement of filing a gift tax return. This rule is known as the "annual exclusion." 

For a married couple, this means $20,000 (plus cost of living adjustments starting in 1999) per recipient, if the gift is of property owned jointly by husband and wife. If the property is owned by one spouse, the other spouse can elect to split the gift with the donor spouse by signing an election on a gift tax return filed with the IRS. Thus, to make a "split gift election," a gift tax return (Form 709) must be filed even if gifts otherwise qualify for the annual exclusion.

Annual exclusion gifts can be an effective way to reduce a taxable estate. Assume, for example, that Mrs. Fine, an elderly widow with a taxable estate of $825,000, has 3 children and 7 grandchildren. Mrs. Fine consults with her estate planning attorney, who recommends that she make a $10,000 gift to each of her children and grandchildren in December and then again in January, reducing her taxable estate to $625,000 (20 gifts of $10,000 = $200,000). If Mrs. Fine dies after making the gifts, her estate tax will be zero (assuming she has available her full 1998 Unified Credit equivalent of $625,000). If she had not made the gifts, the $200,000 excess would have generated an estate tax of $75,000. By making the annual exclusion gifts, Mrs. Fine and her attorney have saved the family $75,000.

Do not be discouraged if your potential donees are minors. Obviously, you do not want to give large sums of money to minor children or grandchildren. In that case, you can set up a gift trust to hold the money or property until the donee reaches adulthood, or you can use the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) under your state's laws by naming a responsible adult as custodian to hold the money or property for the benefit of the minor.

Gifts can be made in cash, securities, real estate, property , an interest in a family limited partnership or corporation, or any other asset that can be transferred to another individual. Gifts of interests in real property or family businesses are particularly attractive because the value of the gift for gift tax purposes can be adjusted downward for lack of marketability and lack of control. The value of the property given away is valued for gift tax purposes under the "willing seller - willing buyer test."

Thus, an undivided one-tenth interest in a parcel of real estate appraised at $120,0000 is not necessarily valued at $12,000 for gift tax purposes . Would you pay $12,000 for a one-tenth interest in a parcel owned by another person or persons? Probably not, because you would be stuck with co-owners and your only way out of the "partnership" might be a suit for partition. You would probably pay less because of this risk and the fact that you could not easily resell your 10 percent interest to another, since he or she would be worried about the same risks. If your appraiser tells you that a discount of 20 percent is appropriate because of the lack of marketability of the interest, the gift tax value would be only $9,600 (10% of $120,000 = $12,000 x .20 = $2,400; $12,000 - $2,400 = $9,600). By taking advantage of such discounts, you can leverage your annual exclusions. Please note, however, that the discount factors are not arbitrary. You will need to hire a qualified appraiser to provide you with a valuation report to attach to the gift tax return in order to substantiate the valuation discounts.

Gift planning using aluation adjustments for fractional interests, minority interests, and lack of marketability is probably the hottest area in estate planning today. The costs involved, such as attorney fees and appraisal fees, are often well worth the potential tax savings. However, before undertaking any gifting plan, you should always consult with a qualified estate planning attorney. The tax rules of making gifts are complicated and gifts, once made, are irrevocable.

Careful gift planning and tax planning is something that American Expats also need to account for.