Q. For tax purposes, is it better to gift an inheritance or wait until after death?
— Planning ahead
A. Before we tackle this question, let’s first review the current gift and estate tax laws.
Federal law provides the ability to make a tax-free gift of $15,000 in 2018 to any individual. This is known as the annual gift tax exclusion (AGTE), said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.
In addition to the annual gift tax exclusion, each taxpayer has a unified gift and estate tax exemption of $11.2 million.
This was increased by the new tax law from $5.6 million, and it’s scheduled to go back down to $5.6 million after Dec. 31, 2025, Papetti said.
With the unified gift and estate tax exemption, you can transfer assets to non-spousal beneficiaries either during their life or at death, Papetti said.
“If you make a gift to someone other than your spouse and exceed the AGTE, you are required to file a Federal Gift Tax Return (Form 709) and reduce the amount of your $11.2 million exemption,” Papetti said. “Therefore, if during your life you made taxable gifts in excess of the AGTE of $1.2 million, you would have $10 million of your exemption left to pass assets tax-free at death to non-spousal beneficiaries.”
For New Jersey purposes, there is no gift tax and effective Jan. 1, 2018, there is no estate tax, Papetti said. But the state does have an inheritance tax when assets pass to Non-Class A beneficiaries.
Let’s break that down further.
Class A beneficiaries face no inheritance tax. These beneficiaries include a spouse, civil union partner (after Feb. 19, 2007), a domestic partner (after July 10, 2004), children, grandchildren, great grandchildren, parents, grandparents and great grandparents, and step-children — but not step-grandchildren.
Class C beneficiaries include brothers and sisters. The first $25,000 is exempt from inheritance tax, then rates start at 11 percent and increase to 16 percent when the transfer exceeds $1.7 million, Papetti said.
Class D beneficiaries are every other beneficiary, such as nephews, nieces and friends, and these are subject to inheritance tax rates 15 percent on the first $700,000 and 16 percent over $700,000.
Now, to answer your question, we’re going to assume you’re a New Jersey resident.
Papetti said there are tax and non-tax considerations regarding whether an asset should be gifted during life or transferred at death.
Before any gift is considered, it assumes the donor has more than sufficient capital to meet their retirement income needs through life expectancy, Papetti said.
If the donor has a non-taxable estate — under $11.2 million or $22.4 million for a married couple — one primary benefit of gifting an asset is to remove it from the claims of Medicaid in the event the donor requires long-term care in a nursing home, Papetti said.
Then consider whether the recipient needs the funds now or later.
“Some parents prefer to see their children enjoy the fruits of their labor while they are alive rather than when they pass,” Papetti said.
Also consider whether the asset is a family legacy asset, for example, a vacation home that the donor wants to make sure stays in the family. If so, gifting to a family trust may make sense.
Papetti said the type of asset to be gifted and to whom it is gifted are primary tax considerations to determine if it is better to make a gift or transfer the asset at death.
If you’re gifting cash, Papetti said, it will remove the asset from the taxable estate and there is no negative tax consequence to the donee.
But if you’re talking about capital gain properties, he said, the best alternative depends on the cost basis of the asset to be gifted.
There’s more to consider if you’re talking about a low cost basis asset.
“In light of the substantial increase in the federal gift and estate tax exemption to $11.2 million per taxpayer, it is generally better to pass a low cost basis asset at death rather than as a gift during life as the beneficiary will receive a `step-up’ in the cost basis of the asset to the date of death value,” Papetti said. “This means the if the beneficiary sells the asset there will be little or no capital gain tax.”
He said if a low basis asset is gifted, the donee receives a carry-over cost basis from the donor which would result in a greater capital gain tax than if it passed through the estate, he said.
“Note that if the donor has a taxable estate in excess of $11.2 million or $22.4 million for a married couple, consideration should be given to gifting the asset as the future growth of the asset will be removed from the taxable estate,” he said. “The potential estate tax savings on the future growth should be compared with the potential capital gain tax savings by passing the asset at death.”
If you’re talking about a high cost basis asset, such as one that has a cost basis at or near the fair market value of the asset, gifting may be the most appropriate strategy, Papetti said. That’s because the future growth will be removed from the donor’s estate as well as removed from Medicaid claims if gifted beyond the five-year look back period.
“When the donee is a Non-Class A beneficiary, it may be more tax advantageous to make a gift to avoid New Jersey inheritance tax than to leave it to the Non-Class A beneficiary as an inheritance,” Papetti said. “The analysis needs to compare any potential inheritance tax with the capital gains tax if the asset has a low basis.”
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