OUR THOUGHTS ON:

Reverse gifting? What is it? Should I do it?

Estate Planning|Tax

By Gregory Allison

All too frequently, high-net worth individuals that have engaged an estate planner have been presented various gifting strategies designed to reduce their overall estate tax liability. These strategies typically focus on removing assets from the individual’s estate through gifts. The ubiquity of these conversations, combined with the longevity of the estate tax, has created a presumption that an effective estate plan, from a tax perspective, for a high-net worth individual, involves some element of gifting.

However, the federal estate tax exemption amount (the dollar threshold that an individual’s taxable estate must exceed in order to be subject to the federal estate tax) has drastically increased since 2002, when it was $1 million per person, to 2015. In 2015, the threshold is $5.43 million per person.  Therefore, unless the individual is projected to have a taxable estate over $5.43 million ($10.86 million for married couples) in 2015, no federal estate taxes will be due.

From an income tax perspective, when a gift is made, no gain or loss on the gift is recognized and the donor’s basis in the property is transferred to the recipient with the gift. For example, if a mother gifts a $500,000 vacation home, which has a basis of $200,000, to her daughter, no income tax is due at the time of the gift. However, if the daughter sells the property for $500,000, she recognizes gain of $300,000 since the daughter’s basis is the same as the mother’s basis. Assuming a tax rate of 23.8% on the sale, her income tax liability is $71,400.

The idea of “reverse” gifting is rooted in the assumption that neither the donor (mother) nor the donee (daughter) will be subject to the federal estate tax. When an individual passes away, the basis of his or her assets are stepped-up to fair market value on the individual’s date of death. Using the example above, what if the daughter gifted the vacation home back to the mother and then sold it after her mother passed away? The daughter would use approximately $500,000 of her $5.43 million exemption to do so. Since the daughter is not anticipated to have a taxable estate, usage of her exemption should be irrelevant. The mother would include a provision in her estate plan to provide that the vacation home would pass to her daughter upon her death. Upon the mother’s death, the basis in the vacation home is stepped-up to $500,000, which is the fair market value of the vacation home on the date of the mother’s death. Then, if the daughter sells the vacation home for $500,000, she reports $0 gain. Note that if this plan were to be implemented, the mother must survive at least one (1) year after the subsequent bequest to her or Internal Revenue Code Section 1014(e) dictates that no basis step-up applies.

Individuals should consider having discussions with their tax advisors to ascertain whether their long-time estate plan needs to be modified in light of the estate tax exemption increases in recent years.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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