There are many reasons that individuals are reluctant to make lifetime (inter vivos) gifts a part of their estate plan. The most fundamental reason is the loss of control over the transferred assets, and the accompanying fear that a donor’s remaining wealth may not be adequate to support him or her for the remainder of his or her life. Another commonly cited objection to making a lifetime gift is the belief that an at-death (testamentary) gift is more tax-efficient; i.e., the belief that deferring taxes until death allows a larger asset base to grow and compound before it is passed along. While the first concern is a very personal and subjective one, the second is generally unfounded.
Inter vivos gifts tend to be more tax-efficient because gift tax is computed only on the value of the gift received by the donee — the dollars used to pay the gift tax are not themselves subject to the tax. In contrast, the funds used to pay the estate tax are themselves subject to the tax — the estate tax is calculated on the entire taxable estate, not just on the residue that passes to beneficiaries after the payment of the estate tax. In addition, since assets tend to appreciate over time, paying taxes earlier in time typically means paying taxes on a smaller asset base. Moreover, a “tax-exclusive” lifetime transfer typically remains superior to a “tax-inclusive” testamentary transfer despite the advantage of a step-up in tax basis of an asset transferred at death; in other words, from a tax standpoint it is ordinarily not sensible to retain property until death simply in order to obtain a new basis on the transferred property.
Of course, this discussion assumes a contemplated transfer of assets in excess of the unified gift and estate tax filing thresholds — currently $1 million at the Massachusetts level and $5.12 million at the Federal level. If you are fortunate enough to have this “problem,” you should strongly consider making a transfer this year, as the Federal exemption is scheduled to revert to $1 million on January 1, 2013. For practical assistance in formulating a tax-efficient wealth transfer strategy, reach out to Freed Law LLC.
