Estate Planner Jan-Feb 2001
What can you do if you want to transfer appreciated property — such as stock or real estate — to your child but lack cash to pay the gift tax? You can make a “net gift.” When you make a net gift, your child (or other recipient) agrees to pay the gift tax and the gift’s value is reduced by the amount of tax your child pays.
Tax Advantages of a Net Gift
A net gift can be useful when you have a large estate, little “free” cash and an illiquid asset. If your child has enough cash to pay the gift tax or can liquidate other assets to do so, you can transfer the illiquid property intact. This technique also makes sense if you (or your parent) are averse to personally paying gift tax or perhaps would incur a taxable gain by liquidating assets to pay the tax. And you may save a capital gains tax if part of your gift must be sold to raise cash to pay the gift tax, because the tax basis of the gift to the recipient is increased by the amount of the gift tax.
A net gift is similar to a sale of an asset for less than fair market value because your child gives you cash in the amount of the gift tax. Thus, the IRS will treat only a portion of the property you transfer to your child as a gift. The amount of the actual gift is determined by an interrelated calculation too complicated to go into here.
You can use the net gift technique even if you haven’t used your entire gift and estate tax applicable exclusion amount — currently $675,000. (The amount of the applicable exclusion is scheduled to increase until 2006, when it will reach $1 million per person.) If all or a portion of your exclusion amount is available, you must first apply it to any taxable transfers you make. Doing so shelters part of the gift from gift tax, and the net gift will apply to the overage.
Your net gift agreement with your child may be implied or expressed. But a written agreement is better in case the IRS, an heir or an executor has questions later.
Of course, with a net gift, your child will receive less property after paying the gift tax than if you pay it. But a net gift will lower the gift tax. For example, assume Jenna has used her applicable exclusion amount and wants to give stock worth $125,000 to her daughter, Katrina. The gift tax will be $31,000 if Jenna pays it. Thus, the cost of giving $125,000 to Katrina is $156,000. But the gift tax is only $24,000 if Katrina pays it, a saving of $7,000. And the gift costs Jenna only the original amount she wished to part with: $125,000, not $156,000, for a total saving of $38,000. Katrina will only receive $101,000 net after she pays the gift tax.
A Net Gift Is Better Than No Gift
A net gift is a win-win estate planning tool: Your child receives your gift of appreciated stock or real estate and pays the gift tax on the transfer that you lacked the cash to pay, thus making the gift possible. If you would like to learn more about this gift tax savings technique, please give us a call.
A net gift can be useful when you have a large estate, little “free” cash and an illiquid asset.