Dear Michael: We read your last column regarding gifting of assets and sales of assets and weren't sure if you were advocating gifting or not advocating gifting of land or other assets to our children. Can you explain this better? – Looking at the 'Fiscal Cliff'
Dear Looking: What I stated in my last article is this. In my opinion, unless you have five million dollars (or ten million if you are married) to give away right now, then it's likely doing any gifting is going to help you for 2012, and may hurt you, in fact.
Why? Because the Unified Credit is not applied until the year of your death and the Unified Credit is the amount you can pass estate tax free to your heirs upon your death.
If you give a gift to any individual(s) of more than thirteen thousand dollars, your 'eventual' (see: year of your death) Unified Credit will be reduced by the amount you exceed the annual exclusion (of thirteen thousand dollars per year per individual).
For example, I panic right now and give $2,500,000 of property away to my children right now because I think estate taxes are going to go to $1,000,000 per person in 2013 – which they may. I think I may have saved my children estate taxes on $1,500,000 at the 55% estate tax rate, right?
The problem is when I gift property to my children today, I do not increase their 'basis' in the property. Basis is what I paid for the property. So, if I paid fifty dollars per acre for the land I gifted away, my children's basis will be fifty dollars an acre, as well. If they sell the land, they will have to pay capital gains on the difference between the original fifty dollar purchase price and whatever the eventual sale price might be. If it sold for one thousand dollars per acre, they would pay capital gains on the additional $950.00/acre increase in value.
Capital gains are another tax in flux right now. Currently, people in the 10% to 15% tax bracket pay no capital gains whatsoever. People or couples in a higher tax bracket were limited to a fifteen percent top tax bracket.
Remember, capital gains are added on to all of your other income (earned, unearned, royalty, etc.) and the calculations are made as to whether or not you had to pay capital gains.
By gifting low basis property today, because of an 'uncertain' estate tax situation, you may be passing 'low basis' property on to your children and they will lose the step-up basis that occurs upon death.
That's an acceptable situation if, indeed, the estate tax credit goes back to $1,000,000 per person because they decided to drive this country right over the Fiscal Cliff. I believe there's at least a 50/50 chance they will allow this to happen on January 1, 2013. I think there's a game of chicken being played by the two political parties with a supposed 'crash' date of 1/1/2013. Which party will flinch first and pull over to the side of the road? At this point, neither party wants to look weak – and so Congress may delay this decision until January or February or May?
It is quite likely Congress will come back and passes estate tax credits of $2,500,000 to $5,000,000 per person ñ which is what is expected ñ eventually. In order to keep the Supreme Court from hearing lawsuits from families who had to deal with this law, itís likely Congress would make this retroactive to 1/1/2013 when they finally agree.
If this occurs, you've pushed the panic button too soon and you've pushed your children from a 'no' tax situation into a capital gains tax situation in the future – and capital gains is guaranteed to rise from 15% to 18.8% on any amounts over $250,000 in capital gains in the future. It's possible the base rate of 15% will change to 20%, as well.
Even though this sounds bad, if you move this much property today, you have to give up all control of this property – either to your children or to an irrevocable trust – and you may have to live with the fact you've given away one hundred percent of your Unified Credit in the future – if it, in fact, turns out to be $2,500,000.
This paints you into a corner as you cannot do any further tax strategies to lessen the burden on your children and you've also created a remainder estate (the property you still own after the gift) where everything you own will be taxed. Having given the gift may lessen your ability to take advantage of certain tax strategies because you no longer have full ownership of the asset.
Right now, it's the million dollar question? When will Congress do something? I know a lot of people want to know what they are going to do but, in my opinion, it's more important to know 'when' they are going to do it and how we can then start planning for that future. For the time being, everyone's stuck in limbo.
Look on the bright side. You could be just getting ready to retire from the company you worked at for the past forty years only to find out Congress's 'game of chicken' just caused your 401k to drop 30% to 50% in value and now you get to retire on half of what you thought you had coming – all for gamesmanship? There are a lot of people who will suffer incredible lack of income problems if this thing continues to play out the way it has been! They'll starve on these actions!