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08 Apr

Protecting UTMA Accounts: What Happens When the Minor Becomes a Major?

In Gifts,UTMA by admin / April 8, 2013 / 0 Comments

Estate Planner Sept-Oct 1998
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An account created under the Uniform Transfers to Minors Act (UTMA) is one of the most commonly used forms of making gifts to children, grandchildren or other young family members. Virtually all states have adopted some form of UTMA that allows you to make gifts to a minor to be held in the name of a custodian during the age of minority. On reaching the age of majority, usually 21 years, the minor is entitled to all assets held in the account. Sometimes, significant assets build up in these accounts in the name of a minor. This may not always be desirable, however, and careful planning can eliminate or minimize problems that can result from early receipt of assets.

How UTMA Accounts Work

To open an UTMA account, you simply advise the bank of the name of the custodian and indicate how much you wish to place into the account. Unfortunately, UTMA accounts are complicated in their simplicity. First, if you establish the account and name yourself as custodian but then die while still acting as custodian, that account will be included in your estate for federal estate tax purposes. Therefore, when establishing this type of an account, you need to choose your custodian wisely.

Second, as indicated above, the account must vest in the minor when he or she reaches the age of majority (in Washington, the account vests at age 21). If you have been putting away money for your children each year, this can result in a large sum being available to your children at a young age. If this occurs, you need to look at what your options are.

Protection Options

What can you do if you realize that large sums of money will be going to a young person who is not ready? Let’s look at the following example:

Tom and Sue Jones have three children. Beginning at each child’s birth, Tom and Sue make annual gifts to them through UTMA accounts. After realizing they have assets that are going to grow much in value, Tom and Sue decide to make larger gifts to their children; up to the $20,000 joint annual limit for exclusion from gift taxes. By the time the children are 10, 12 and 14, they each have UTMA accounts of $500,000 with Tom as custodian.

Tom and Sue visit their estate planning advisor because they are concerned about how large the UTMA accounts have become. The advisor offers a couple of options. One is to convince the children as they approach the age of majority to establish trusts for their own benefit and place the funds in the trusts. The trusts would be irrevocable, but would be for the sole benefit of the child. The trusts would be established to ensure that transfers into the trusts would not be taxable gifts. This approach can work well, but leaves a lot to chance. A young person might look at the short-term gain of so much money and ignore that in the long run, they may receive no more.

Another option is to form a limited partnership or limited liability company (LLC). The partners or LLC members would be the custodians under UTMA. Tom could even be the general partner or LLC manager. Perhaps Sue could act as custodian and then transfer the assets from the UTMA accounts into the partnership in exchange for partnership interests or into the LLC for membership interests. On reaching the age of majority, each of the children would then hold limited partnership or LLC interests rather than cash or marketable securities. The partnership or LLC assets remain somewhat protected because, after all, how much can an individual do with a limited partnership or LLC interest?

Now Is the Best Time To Plan

If you find yourself in the position of making a decision about your children’s assets, we would be pleased to discuss the alternatives with you.

Two Trust Options

Establishing a trust for the benefit of the minor child or children can protect assets and can offer you more control. The assets can remain in trust for as long as you desire and, if drafted properly, the trust can allow gifts into it to qualify for annual exclusion from gift tax. Two types of trusts are most commonly used: the Crummey trust and a trust established under 2503(c) of the Internal Revenue Code (IRC).

The Crummey trust, named after the case of Crummey vs. Commissioner, is designed so that gifts made to the trust are subject to rights of withdrawal by the beneficiaries. The right of withdrawal generally lasts for 30 days, after which time the right lapses. Under current law, because the beneficiary has a right to withdraw the gift made to the trust, the gift will qualify for annual exclusion from gift tax. The beneficiary must also have notice of the withdrawal right. If the beneficiary of the trust is a minor, notice to a parent is sufficient.

The 2503(c) trust is created specifically under the IRC. Gifts into the 2503(c) trust will qualify for annual exclusion from gift tax. The proviso here is that when the trust beneficiary reaches age 21, he or she must have the right to receive the trust assets. This right need not, however, be an unlimited right. Rather, the beneficiary can be given notice that on reaching age 21, he or she has the right to withdraw all of the trust assets for a period of, say, six months. At the end of that time, if the right is not exercised, the right will lapse. On the assumption that a child will listen to the sound advice of the parent and not exercise the right of withdrawal, upon lapsing of the right of withdrawal, the trust converts to an ordinary trust that can continue for as long as the terms of the trust provide.

Both the Crummey Trust and the 2503(c) trust, however, require the preparation of a trust agreement and also require annual administration of the trusts to ensure that all of the requirements are followed. To avoid this administrative burden, many people establish UTMA accounts instead.

08 Apr

Take Advantage of New Gift Tax Statute of Limitations

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 1999
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Until recently, an anomaly in the Internal Revenue Code statute of limitation for gifts allowed the Internal Revenue Service (IRS) to attack the value of a gift in determining the amount of the estate tax. Now, under the the Taxpayer Relief Act of 1997, once the gift tax statute of limitations has run out, gifts that are adequately reported on a gift tax return may not be revalued by the IRS for the purpose of computing the estate tax.

Before the Act

For estate tax purposes lifetime gifts are added back to determine the taxable estate, and credit is then given for any gift tax paid. Before the act, the value of a gift was the amount reported when the gift tax was assessed or paid and the statute of limitations (generally three years) had run out. The statute of limitations prevented an IRS attack on the value of gifts reported on gift tax returns for gift tax purposes. But, because it didn’t prevent an attack on the value of the gift by the IRS for estate tax purposes, the IRS could redetermine the value of a prior gift, increasing the estate tax. The effect was slightly offset by the estate receiving a credit for the gift tax that would have been paid if the higher value had been reported on the gift tax return.

Advantages Under the Act

Legislation in 1998 has clarified that the finally determined value of the gift (i.e., the value when the statute of limitations lapses) controls the value used in determining the amount of a taxable gift even if no gift tax was paid or assessed on the gift. So, if the IRS does not issue a final notice of redetermination of value within the applicable statute of limitations, then it may not revalue a gift that has been adequately disclosed on a gift tax return. It is a good idea to make gift disclosures in enough detail so they won’t be attacked by the IRS as inadequate. Even after the changes made by the Act, the statute of limitations will not run on a gift that is not adequately disclosed.

Another benefit under the new law is that you may request a hearing before the U.S. Tax Court on the valuation of gifts, and the court can issue a declaratory judgment to determine the value of gifts. The court may make such judgments even where the gift is sheltered from tax by the applicable exclusion amount.

Caution Areas

Not all of the changes under the act relating to the valuation of gifts are favorable. The six-year statute of limitations that applied to “substantial omissions” regarding the reporting of gifts (the omission of over 25% of the total amount of gifts reported on the return) applies only if the gifts were adequately disclosed. Otherwise, an unlimited statute of limitations now applies. And if no return is filed, there continues to be no applicable statute of limitations for gift tax purposes.

Also, the relief only applies to gifts made after August 5, 1997, so those made earlier remain subject to attack for estate tax purposes even after the gift tax statute of limitations has run.

Although the generation-skipping transfer (GST) tax statute of limitations may not run until much later, by allocating the GST exemption on a timely filed gift tax return, the value of the property will be determined on the running of the gift tax statute of limitations for the purpose of determining the GST exclusion ratio.

The fact that the IRS can no longer revalue gifts for either gift or estate tax where no gift tax is owed or assessed and where the statute of limitations has run provides welcome relief from the uncertainty that previously existed. But continue to properly and adequately report gifts when made, because other changes in the law expand the statute of limitations in some situations to six years and an unlimited time in others.

Please let us know if you have any questions about properly filing gift returns and about the changes in the IRS statute of limitations for gifts. We would welcome the opportunity to help you take advantage of the new laws.

08 Apr

Make Net Gifts Now, Save Later: Reduce Estate Tax Liability by Having Donees Pay Gift Taxes

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Nov-Dec 1997
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Making lifetime gifts to reduce estate tax liability is an underused estate planning technique. Why? Perhaps because you don’t want to use your remaining resources to pay the gift taxes. You may, however, want to consider gifting property on the express condition that the donee pay the gift tax. These arrangements are termed “net gifts.”

Net gifts can significantly reduce estate tax at your death because you remove from your taxable estate the gifted property itself, the tax on the gifted property (assuming you outlive the transfer by at least three years) and all future appreciation on the property.

Determining the Net Gift’s Value¬†

The value of the net gift for gift tax purposes is the fair market value of the asset less the gift tax payable. Because the amounts of both the gift and the gift tax are mutually dependent, an algebraic formula or an appropriate software program is necessary to determine the gift.

Capital Gains Tax Consequences

Net gifts can have capital gains tax consequences. The donor is essentially receiving consideration for the transfer in the amount of the gift tax to be paid by the donee. The Internal Revenue Service (IRS) has taken the position that the donor receives an economic benefit if the gift tax due exceeds the donor’s basis.

For example, assume the value of the gift property is $100,000 with a tax basis of $20,000, and the gift tax due on the gift is $30,000. The IRS deems that by receiving the $30,000 tax liability from the donee in exchange for the gift property, the donor has realized a $10,000 gain ($30,000 gift less $20,000 basis equals a $10,000 gain). This gain will be subject to capital gains tax.

Consequently, a donor should gift property with a tax basis equal to or slightly higher than the gift tax liability on the transfer. Another way to avoid potential capital gains tax is to make the gift but hold back sufficient funds to pay the gift tax. This approach works best when gifting cash or other liquid assets.

Leveraging Net Gifts

As is any lifetime gift, a net gift is particularly useful for transferring assets that are likely to appreciate significantly in the future. This appreciation can then take place in the hands of a younger generation. If the donee does not have the funds to pay the gift tax, he or she may be able to borrow the needed amounts by using the gifted property for collateral.

Will a Net Gift Benefit You?

Having the donee assume the liability for payment can allow you to reduce your estate tax burden. If you would like help determining whether this technique will benefit you, give us a call.

 

Case Study: No Gift vs. Net Gift*

Jane intends to leave her entire $30 million estate to her daughter, Mary. At Jane’s death, an estate tax of $16.5 million will be due, leaving Mary with assets totaling $13.5 million.

If, instead, Jane makes a lifetime gift to Mary of $10 million, and conditions the gift on Mary paying the gift tax, total transfer taxes will be less. Of the $10 million Jane transfers to Mary, $6,811,290 will be the value of the gift and $3,188,710 will be the gift tax owed on the gift. At Jane’s death, the estate tax due will be $11,558,000. Mary will have paid a total of $14,751,710 in transfer taxes — more than $1.75 million less than if no net gift had been made.

*This example is based on 1997 estate and gift tax rates and exemptions.

Total Transfer Taxes Paid

No Gift Net Gift of $10,000,000
Gift tax $3,188,710
Estate tax $16,500,000 $11,558,000
Total tax $16,500,000 $14,746,710
Additional tax $1,753,290

Amount Received by Mary

No Gift Net Gift of $10,000,000
From gift $6,811,290
From estate $13,500,000 $8,442,000
Total $13,500,000 $15,253,290
From tax Savings $1,753,290

08 Apr

Making Gifts Before They Become Tax Exempt Can Save You Money

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Nov-Dec 1997
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On Jan. 1, 1998, the Taxpayer Relief Act of 1997 begins phasing in an estate and gift tax unified credit equivalent increase, from the current $600,000 to $1 million, according to the following schedule:

Changes in Gift and Estate Tax Exemption Equivalent

1998 $625,000
1999 $650,000
2000 & 2001 $675,000
2002 & 2003 $700,000
2004 $850,000
2005 $950,000
2006 $1,000,000

This tax law change is good news for those with substantial estates and those who have already used up their $600,000 exemptions. These individuals can now transfer additional amounts without incurring gift or estate taxes.

Against this backdrop, let’s examine why financial planners have been trying to persuade their older and wealthier clients to make taxable gifts in excess of the exemption amount and pay a gift tax.

Gift Taxes Are Less Expensive Than Estate Taxes

The mathematics can prove that writing a check for gift taxes, as painful as it may seem at the moment, will probably save your family a lot of estate taxes, provided you survive for at least three years after the date of the gift.

This is true because 1) a current gift removes future appreciation on the assets given away from your estate, and 2) gift tax rates are effectively lower than estate tax rates because tax is paid only on the amount of the transfer itself, not also on the amount of the tax.

The latter point is illustrated by the over-simplified example on the next page, which shows that the children get to keep two-thirds of the total funds when they receive a gift, but only half of the total funds when they inherit them.

Making Taxable Gifts Under the New Law

Now, let’s look at what happens when an individual has given away or will give away the current exemption amount of $600,000 and is willing to give away an additional amount of up to $400,000 (double both amounts for a married couple). Should the gift be made in 1997 before the exemption amount begins to increase or in annual increments as the exemption increases to $1 million?

The chart below assumes a fund of $553,000 (the amount necessary to make a $400,000 gift, plus pay the gift tax), a 6% after-income-tax investment rate of return, and the maximum estate tax rate of 55% for an individual who has already used the $600,000 exemption. It compares three scenarios:

a. No additional gifts,
b. An additional $400,000 gift spread over a period of years coinciding with the exemption increases, and
c. An additional 1997 $400,000 taxable gift.

The results show that doing nothing clearly is not the best course of action. The figures also show that if an individual makes the 1997 gift of $400,000 and lives for 10 years, his or her heirs will receive roughly $143,000 more than if the individual makes the same gifts gradually as the exemption increases.

Act Now To Reap Maximum Benefits

Is this strategy right for you? First ask whether you can afford to part with the funds (the gift plus the tax) needed to implement such a strategy. If you can, analyze your situation, including your age, projected estate tax bracket, projected investment rate of return and other available planning opportunities. You can then decide if you are ready to take what may seem a bold step but will actually be a smart move. The opportunity will slowly begin to slip away Jan. 1, 1998, so let us know if we can help you choose the best course of action for your situation.

Gift No Gift
Gross amount of funds used $1,500,000 $1,500,000
Amount of gift (1,000,000)
Gift tax (500,000)
Amount taxed at death 1,500,000
Estate tax (750,000)
Net to heirs $1,000,000 $750,000
Percent to heirs 66.67% 50%

08 Apr

Time Your Gifts To Gain Maximum Tax Benefits

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Jul-Aug 1997
______________________________________________________

The goal of any gifting plan is to remove the most value from your estate at the least tax cost. Many estate planning techniques are interest-rate sensitive — the perceived benefits increase or decrease as interest rates change.

The applicable federal rate (AFR) is determined by the U.S. Treasury each month, based on the US average market yield on outstanding marketable obligations with remaining periods to maturity for each of three types of terms: 1) short-term — not more than three years, 2) mid-term — more than three years but not more than nine years and 3) long-term — more than nine years. These rates may change each month depending on what happens with market interest rates.

Projecting whether the AFR will go up or down often will help you better choose among different types of gifting programs. All planning techniques involving annuities, interests for a term of years, interests for life, or remainder or revisionary interests require valuations. The valuations are based on tables that use an interest rate of 120% of the mid-term AFR for the month of the value date (or, for valuations involving charitable contributions, for either of the two months preceding the transfer date).

For noncharitable trusts, you want the value of the gift for gift tax purposes to be as low as possible so it will cost you less in taxes. For charitable trusts, on the other hand, you want the value of the gift for gift tax and income tax charitable deduction purposes to be as high as possible so you can remove more from your estate gift tax-free and receive a higher income tax deduction.

Let’s look at some estate planning ideas and see whether it would be better for you to plan when interest rates are higher or lower.

Qualified Personal Residence Trust (QPRT)

Under a QPRT, you transfer your principal residence or vacation home into a trust for the benefit of your children or others while retaining the sole right to use the residence for a specified term. The value of your gift is equal to the current fair market value of the residence less the present value of your right to use the property during the reserved term. You use present value tables to leverage your gift and shift all future appreciation out of your estate.

Example: You have a residence or vacation home worth $500,000. You want to transfer it to a QPRT, retaining the right to use the residence for a term of 10 years (with no reversion if you do not survive).

If the 120% AFR is The value of your retained interest The value of your gift
6% $220,803 $279,197
10% $307,229 $192,771
14% $365,128 $134,872

Conclusion: QPRTs are more efficient when interest rates are higher.
Grantor Retained Annuity Trust (GRAT)

Under a GRAT, you transfer property that you believe will appreciate into a trust for the benefit of named or identified beneficiaries. You retain a right to receive an annuity from the trust for a set number of years. The annuity is a set percentage of the value of the property at the time of the transfer. Again, you are leveraging your gift and shifting future growth to your children or other beneficiaries. The value of your gift is equal to the property’s current fair market value less the present value of your right to receive the annuity for the trust term.

Example: You transfer investment real estate worth $500,000 to a GRAT in exchange for the right to receive 8% ($40,000) per year for 10 years.

If the 120% AFR is The value of your retained interest The value of your gift
6% $294,404 $205,596
10% $245,784 $254,216
14% $208,644 $291,356

Conclusion: GRATs are more efficient when interest rates are lower.
Charitable Remainder Annuity Trust (CRAT)

Under a CRAT, you transfer property into an irrevocable trust from which a set amount is paid each year to one or more beneficiaries (which can include you) for any term up to 20 years or over the life or lives of one or more of the beneficiaries. The property remaining in the trust at the end of the term passes to charity. The value of your gift to charity (the remainder interest) for gift tax and income tax charitable deduction purposes is equal to the fair market value of the property at the time of transfer less the present value of the payment rights reserved to the beneficiaries.

Example: You are 51 years old and transfer securities worth $500,000 to a CRAT in exchange for the right to receive an annuity of 8% ($40,000) per year for your lifetime.

If the 120% AFR is The value of your retained interest The value of your gift
6%* $493,268 $ 6,732
10% $344,148 $155,852
14% $260,480 $239,520

* Illustration purposes only because it fails the “5% test”

Conclusion: CRATs are more efficient when interest rates are higher.
Charitable Remainder Unitrust (CRUT)

A CRUT is similar to a CRAT, except, instead of a set amount being distributed, a fixed percentage of the net fair market value of the trust property, revalued annually, is paid each year to one or more beneficiaries (which can include the grantor). The term of the CRUT interest may be for the life or lives of one or more of the beneficiaries or for a fixed number of years (not to exceed 20). The remainder at the end of the term is paid to charity. The value of your gift to charity for gift and income tax charitable deduction purposes is equal to the present value of the remainder interest, which will take into account the reserved term or life interests.

Incidentally, CRATs and CRUTs are tax exempt. If appreciated property is transferred to them, the sale of the property by the trust will not be subject to capital gains tax. The annual distributions to the beneficiaries, however, may be subject to tax.

Example: You are 51 years old and transfer securities worth $500,000 to a CRUT in exchange for the right to receive an annuity of 8% per year for your lifetime. The 8% is recomputed each year based on the fair market value of the trust property. Assume one payment is made annually and the trust is revalued one month prior to payout.

If the 120% AFR is The value of your retained interest The value of your gift
6% $415,645 $84,355
10% $415,290 $84,710
14% $414,930 $85,070

Conclusion: CRUTs are not significantly affected by changes in the interest rates.
Charitable Lead Annuity Trust (CLAT)

A CLAT is like a CRAT except the set amount paid out of the trust each year goes to one or more charities and the trust assets remaining at the end of the trust term go to your children or other named beneficiaries. The value of your gift to charity for gift and income tax charitable deduction purposes is the present value of the stream of payments to be made to charity over the term.

Example: You transfer securities worth $500,000 to a CLAT for a 15-year term and direct that 10% ($50,000) be paid out annually to a named charity.

If the 120% AFR is The value of your retained interest The value of your gift
6% $14,390 $485,610
10% $119,695 $380,305
14% $192,890 $307,110

Conclusion: CLATs are more efficient when interest rates are lower.
Charitable Lead Unitrust (CLUT)

A CLUT is similar to a CLAT except, instead of a set amount being distributed, a fixed percentage of the net fair market value of the trust property, revalued annually, is paid each year to the charities. The value of your gift to charity for gift and income tax charitable deduction purposes is the present value of the stream of payments to be made to charity over the term.

Example: You transfer securities worth $500,000 to a CLUT for a term of 20 years and direct that 10% of the annual value of the trust be paid out each year to a named charity.

If the 120% AFR is The value of your retained interest The value of your gift
6% $61,465 $438,535
10% $61,893 $438,107
14% $62,293 $437,707

Conclusion: CLUTs are not significantly affected by changes in the interest rates.
Fine-Tune Your Gifting Program
As interest rates rise, the value of term and lifetime annuity payments decrease and the value of remainder interests increase. You may benefit from gifting at the best time.

08 Apr

Timing Can Be Everything To a Successful Gifting Program

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Jul-Aug 1997
______________________________________________________
Many estate planning techniques are interest-rate sensitive — the perceived benefits increase or decrease as interest rates change. Projecting whether interest rates will go up or down often will help you make gifts that remove the most value from your estate at the least tax cost — the underlying goal of any gifting program.

How Do Interest Rates Affect Your Gifts?

The applicable federal rate (AFR) is determined by the U.S. Treasury each month based on fluctuations in market interest rates. All planning techniques involving annuities, interests for a term of years, interests for life, or remainder or revisionary interests can be greatly affected by the AFR. Why? The value of the gift for tax purposes is determined with tables that use an interest rate of 120% of the midterm (more than three years but not more than nine years) AFR.

Case Study: Qualified Personal Residence Trust (QPRT)

Under a QPRT, you transfer your principal residence or vacation home into a trust for the benefit of your children or others while retaining the sole right to use the residence for a specified term. The value of your gift is equal to the current fair market value of the residence less the present value of your right to use the property during the reserved term. You use present-value tables to leverage your gift and shift all future appreciation out of your estate.

Example: You have a residence or vacation home worth $500,000. You want to transfer it to a QPRT, retaining the right to use the residence for a term of 10 years (with no reversion if you do not survive).

If the The value The value 120% of your retained of your AFR is interest is gift is 6% $220,803 $279,197 10% $307,229 $192,771 14% $365,128 $134,872
Conclusion: QPRTs are more efficient when interest rates are higher.

Time Is Money

For gifts to noncharitable trusts, you want their value for gift tax purposes to be as low as possible. By considering interest rate trends, you may be able to make the most (or least) of your gifts by timing them right.

For more information on how timing can affect the tax benefits of your gifts, including gifts to charitable trusts, contact us at the number above. We will send you a complimentary copy of the in-depth report “Time Your Gifts To Gain Maximum Tax Benefits.”

08 Apr

Have You Made a Gift Without Knowing It?

In Gifts by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 1997
______________________________________________________

Although many transfers obviously qualify as taxable gifts for federal tax purposes, not all taxable gifts consist of a direct transfer from the donor to the donee. Indirect gifts occur in a multitude of settings, and being aware of the various types of indirect transfers can avoid unintended results. Two types of transactions involving indirect taxable gifts are of special concern: loans and powers of appointment.

Look at Low-Interest-Rate And Interest-Free Loans

Certain interest-free and below-market-interest-rate loans result in a taxable gift from the lender to the borrower. The lender is treated as making a gift of the amount necessary to pay the market rate of interest on the loan in excess of the actual interest rate of the loan.

For demand loans (loans due and payable at any time at the demand of the lender), the gift amount equals the amount of the foregone interest calculated by using the Applicable Federal Rate (AFR), published monthly by the Internal Revenue Service (IRS). For term loans, the gift amount equals the excess of the amount loaned over the present value of all payments due under the loan, determined as of the day the loan was made, using a discount rate equal to the AFR.

There is an exception for certain small loans: Generally, a taxable gift of the foregone interest is ignored for gift loans directly between individuals when the aggregate outstanding loans between them does not exceed $10,000.

Consider Powers of Appointment

A general power of appointment usually exists under a trust arrangement. It is a right or power to direct the trustee to distribute assets in favor of the power holder, his or her estate, or his or her creditors. Such a power is unrestricted, and distributions are not limited by an ascertainable standard (such as only for his or her reasonable support, maintenance, education and health). The exercise of a general power of appointment, as well as the release of a general power of appointment, is a gift by the holder of the power to the recipients of the assets over which the power could have been exercised.

Similarly, the failure to exercise a general power of appointment before the power lapses is a taxable gift by the holder of the power. Unlike the release, the value of the gift is the amount by which the lapse exceeds the greater of $5,000 or 5% of the value of the trust assets over which the power could have been exercised (the 5-and-5 rule).

Lapses of powers of appointment often are associated with irrevocable trusts where the cash or other contributions to the trust are subject to limited withdrawal rights granted to the beneficiaries (Crummey rights). The Crummey withdrawal rights are powers given to the beneficiaries to withdraw all or a part of the gifted funds for a limited period of time and therefore are general powers of appointment.

Granting Crummey rights allows the gifted funds to qualify for the $10,000 gift tax annual exclusion. Assuming the withdrawal rights are not exercised, the funds are then available to pay premiums. Therefore, it is not desirable for the right of withdrawal to remain, and the Crummey rights generally are structured to lapse each year within the 5-and-5 rule discussed above, resulting in a gift with no federal gift tax consequences.

Other Ways You May Make a Gift Without Knowing It

Loans and powers of appointment are not the only areas where an unintended gift can occur. Here are some common situations where unintentional gifts may be made:

Third Party Transfers. You transfer assets to a third person with the understanding that he or she will transfer the property to someone else. The assets are a taxable gift from you to the ultimate recipient of the property.

Forgiveness of Loans. You make a loan to a child or other relative with the intent of forgiving part of the debt each year in an amount equal to the gift tax annual exclusion. The whole loan amount is a taxable gift in the year the loan is made because you have no intent to collect on the loan.

Joint Bank Accounts. You establish a bank account or a brokerage account (where the investments are held in nominee or street name) as a joint account. The noncontributing joint owner makes a withdrawal from the account for his or her own benefit. This withdrawal is a taxable gift from you. (No taxable gift is made at the time the account is established.)

Life Insurance Premiums. You pay premiums on an insurance policy on your life that is owned by an irrevocable life insurance trust. The payments are taxable gifts to the trust beneficiaries. Similarly, premium payments you make on an insurance policy on your life owned by any third party are a gift to that third party.

Life Insurance Proceeds. You own an insurance policy on your life. Your spouse is named as beneficiary. You make a gift of the policy to your children to get the policy out of your estate. If you die without your children having changed the beneficiary designation to themselves, your children will have made a gift of the insurance proceeds to your spouse.

Payment of Outstanding Mortgage. You pay the outstanding balance of a mortgage on a principal residence held in a Qualified Personal Residence Trust (QPRT) after it is established and before the end of the trust term. This payment is a taxable gift to the remaindermen beneficiaries. Also, under a QPRT, any improvement or remodeling of the residence paid for by the grantor of the trust is a gift.

Relinquishing Pension Plan Rights. You relinquish your vested rights in your employer’s contributions under a nonqualified pension or profit-sharing plan and trust. You have made a taxable gift to the other plan participants.

Gift of Stock From Child to Grandchild. You transfer common stock in a family-owned corporation from you to your child. Under the new estate freeze rules, this transfer may be a taxable gift by your parents to your child if your parents own preferred stock in the family-owned corporation.

Lapse of Voting or Liquidation Rights. You lapse your voting or liquidation right in a corporation or partnership. This lapse is treated as a taxable gift by you if you and members of your family hold, both before and after the lapse, control of the entity and if the lapse occurs during your lifetime.

Disclaimers of Property. You make a disclaimer of property either later than nine months after the property interest is created or that causes the disclaimer not to be a qualified disclaimer. For federal gift tax purposes, you have made a taxable gift to those who receive the property.

Awareness Is the Key

Lifetime gifts play a major role in many estate plans. Significant tax savings can be achieved that would not be available if the transfers were delayed until death. However, a gifting program should occur by intent and not by default.

The federal gift tax laws contain many different provisions that can cause unintended gifts by an estate owner. All intrafamily transactions involving corporations, limited liability companies, partnerships, trusts and buy-sell agreements can give rise to gift tax consequences and should be carefully planned.

Awareness of the situations that give rise to indirect gifts is essential, both to take advantage of the tax saving potential available through lifetime gifts and to prevent taxable gifts from occurring through innocent transactions.