Russell Stanaland Estate Planning Law Blog on Lawyers.com

As a San Francisco estate planning lawyer and CPA, there are occasions when I advise my clients that it makes sense to pay tax before you absolutely have to. I am referring to estate and gift tax.  Strange as it may sound, sometimes it is a good idea to pay it early.  Some background is necessary to understand why.

We have a unified gift and estate tax in the U.S.  If you have enough money, there is a tax on the value of all the assets you own at the moment of death plus all the taxable gifts you made during life.  For purposes of calculating taxable gifts, there is an annual exclusion of $13,000.  This means you are allowed to make gifts of $13,000 or less to as many people as you like each year.  For example, if you have four grandchildren you can make gifts totaling $52,000 each year and not treat the transfers as taxable gifts.  If you make a gift greater than $13,000 to one person in any one year, the excess over $13,000 will be a taxable gift and therefore included in your estate when you die.  Also, when the taxable gifts made during life exceeds $1,000,000 you must start paying the gift tax immediately, not on your death.  The tax rate on these gifts is exactly the same as the estate tax rate.  This sounds harsh, but paying the gift tax during your life, instead of waiting for your executor to pay estate tax after your death may actually save your heirs money.

An example of how this works may make it clear.  Let’s say you have already made taxable gifts equal to $1,000,000 so any future gifts will force you to pay tax in the year you make the gift.  Also, you are reasonably certain that your estate will be large enough to be subject to estate tax on your death.  Let’s assume the gift tax rate and the estate tax rate is 50 percent.  If you would like to make a bequest to one person of $1,500,000 you have two choices; you can leave it to them on your death or you can give it to them now.  Either way the transfer will be subject to a 50 percent tax, however, the end result is very different.  If you leave them the money on your death there will be a 50 percent tax on the full $1,500,000 so there will only be $750,000 left.  Instead, if you make a gift during your life of $1,000,000 the tax will be $500,000.  In the first case your beneficiary gets $750,000, while in the second case he or she gets $1,000,000.  The reason is, in the first case the money that is used to pay the tax is, itself, subject to tax.  In the second case you paid the tax during your life, therefore the money used to pay the tax was removed from your taxable estate.

A few caveats are required here.  This does not work for deathbed transfers.  You must live for at least three years after the gift is made or the gift tax paid is included in your estate.  Also, the current uncertainty as to the future status of the estate tax makes it difficult to determine whether or not an estate will be taxable in the future.  Using this tactic on marginal estates may result in paying an unnecessary tax.  Obviously you would not deplete your assets and jeopardize your financial security, but in the right circumstances, this can significantly reduce estate tax and get the money to family members during your life so you are still around to reap benefits of the resulting gratitude.

Visit LernerVeit.com to find out more about tax and estate planning  matters or to connect with one of our San Francisco real estate lawyers or business attorneys.

Russell Stanaland
Lerner, Veit & Stanaland, LLP
744 Montgomery St # 5
San Francisco, CA
1-877-532-1899