When it comes to substantial gifts and wealth transfer within the family, there are strategies that can be used to minimize taxes, and maximize the financial security those gifts create for family members and loved ones.
Utilize the annual gift exclusion by giving stock
On the federal level, before taxes are imposed on gifts there is the annual gift tax exclusion. This is currently $17,000 per recipient per taxpayer (so $34,000 for married couples), and it is going up to $18,000 in 2024. With larger estates, this may not seem like a large amount, but if there are many recipients and a gifting strategy is started early, it can really add up. Consider this hypothetical example:
George and Emily “won the lottery,” so to speak, three times in their lives. The first time was how they met—all of the random factors that made them choose the same college, and sit next to each other in a creative writing class. The second was the miracle of raising their four challenging children, who now have six children of their own. The third was their steady portfolio investing over the long term, which included several investments that “overperformed.” In short, they now have more than will be needed for a financially secure retirement. The couple wishes to share their wealth with their family. They have a number of options.
One option would be to sell investments, and then provide cash to their children and grandchildren. Given their low tax basis in the investments, this could push them into a higher tax bracket, and taxes on the capital gains. Another option is to give shares of stock directly to children, in increments below the $17,000 threshold. Should George and Emily gift each child and grandchild $30,000 worth of stock between the two of them, that would be $300,000 in gifts that fall under the annual exclusion. If they do that for 10 years, they will have transferred $3 million tax-free. The second strategy comes with the additional bonus that it may help the children start investing themselves, an opportunity to share the story of why and how the gifted stocks were chosen and kept, and the potential for dividends and additional growth should the children keep the stock.
Gifted shares take the tax basis of the donors, which means the children will have to pay taxes on their capital gains when they sell the shares. Still, they are likely in lower tax brackets than their parents, especially the grandchildren.
Pros and Cons: For estates of moderate size, which have very little to fear from the federal estate tax, planning for taxes capital gains may be a more important planning consideration. Taxes on capital gains are generally avoided for assets held until death. Still, the value of starting an investment plan early may be more important than tax considerations.
Consider locking in the transfer tax exemption amount
Estate taxes are hard to plan for because you can’t know what the tax laws will be when you die. However, you can utilize the currently available laws to try to limit your estate’s liability in the future.
The second amount that comes into play is the lifetime gift and estate tax exemption. This is currently $12.92 million and is set to go up to $13.61 million in 2024. This is per individual, so a married couple such as our hypothetical George and Emily would be able to gift $25.84 million. Should they gift more than the annual exclusion of $17,000 to any individual this year, they would still would not owe gift taxes until the larger exemption is consumed.
However, this historically large amount free from estate and gift tax will be cut roughly in half after 2025, unless Congress decides to change the law. This is causing some wealthier families to consider “locking in” the current exemption amounts by making transfers now of very large gifts. Should the recipients not be ready for those gifts yet, they might be put in a trust to safeguard them.
Pros and Cons: “Locking in” the larger exemption by making a gift may avoid substantial inheritance taxes in the future. On the other hand, you may be losing access to assets before you are really ready to, for a potential taxation change that may not even happen.
It’s not just federal laws that should be considered in wealth transfer planning. New Jersey and Pennsylvania both still have state death laws in place to consider. One might want to consider making substantial charitable gifts, and how to do so in a way that the charity gets the most money and the family’s financial situation is still protected, or perhaps creating an incentive trust that promotes particular family values such as education or home ownership.
That’s where Garden State Trust Company can help. We understand these ins and outs and would be pleased to provide a consultation regarding your wealth transfer objective.