Gifting is a strategy that has always been used by estate planners to remove assets from a client's estate in order to reduce estate taxes. But given tax changes in recent years, it might be time to rethink that strategy.

With the current federal estate tax exemption of $5,430,000, twice as much with portability, many clients no longer face a federal estate tax.  Furthermore, more than half of the states no longer have an estate tax. For those that do, the tax rate is significantly lower than the federal rates. Here are four steps that will help your client decide whether or not to gift. 


There are several questions that you need to ask before recommending gifting to your client. Among the most important are: Is the client really facing an estate tax? If yes, what is the magnitude of the tax? Is it federal and state estate tax? Does it make sense from a total tax perspective (income and estate taxes) to make the gift? What is the potential appreciation of the asset to be gifted? What is the tax basis of the assets to be gifted? Once you are able to discuss these questions with your client, you'll be able to better understand the best course of action for gifting.


When a person makes a gift, the tax basis, or the amount from which a potential capital gain tax is calculated, transfers over to the recipient. This is known as "carryover basis." When the recipient later sells the asset, the recipient may have to pay a capital gain tax on the difference between the basis and the sales price.


It may be better to have an asset owned by someone when they die. That way the asset will be part of the person's estate for estate tax purposes because the asset will receive a "step-up in basis" to the fair market value at the time of the person's death. The recipient (from the estate) could then sell the asset and pay no capital gain taxes.

Given the relatively high estate tax exemptions that now exist it could be that little or no estate taxes would be owed and capital gains are wiped away due to the basis step-up. Even if a state estate tax needs to be paid, often that tax rate is between 8 percent and 16 percent, which is lower than a potential combined federal and state capital gains tax rate of which are often in the range of 30 percent.


Let's assume that Jane, who lives in Massachusetts, has as an estate of less than $1,000,000 and has made no prior gifts. Jane has stock in Widget Co. that she bought for $10,000, with a current value of $100,000. Jane could gift the stock to her son, who would then have to pay a tax on a $90,000 gain when he sells the stock (because he received Jane's $10,000 basis with the gift).

Alternatively, Jane could keep the stock and, when she passes away, leave the stock to her son. If her son then sold the stock for $100,000, he would have no gain to report due to the basis step-up. If we assume that her son's tax rate on capital gains is 23.8% federal and 5.2% state, the step-up in basis reduced his tax bill by approximately $26,000. Even if Jane had a taxable estate of $3,000,000 in Massachusetts, the marginal tax rate would be 8.8%. Jane's estate would pay a state estate tax of $8,800, versus the capital gain tax of $26,000 paid by Jane's son.

Many clients like our hypothetical Jane want to leave their loved ones with a substantial asset or assets. While there can be many instances in which it does make sense to make a lifetime gift, consideration must be given to all tax aspects of making the gift, especially capital gains taxes. Overlooking an aspect of this due diligence process can leave the beneficiary of your client's goodwill at a significant tax disadvantage.

Attorney Allen Falke is a member of Massachusetts-based Mirick O'Connell's Business and Trusts and Estates Groups. He focuses his practice on tax law and estate and business planning.

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