July 18th, 2017

Effective wealth management is about much more than picking the right stocks and bonds for your portfolio

In fact, one of the biggest concerns our clients face has to do with the potential estate taxes that their heirs will owe when they die.

As a reminder on how estate & gift taxes work, there are two main concepts to remember:

  1. Each person can gift up to $14K per year to as many people as you want to and owe no gift tax. So a married couple with 3 kids (and their spouses) and 3 grandkids can give away $252K per year and owe no gift taxes. To break that down, it’s $14K X 2 spouses X 9 beneficiaries = $252K per year without any gift tax. If you employed this strategy for the next 10 years you would have gifted away $2.5M without any gift taxes due
  2. Each person can leave up to $5.45M to their heirs, either at death or during their lifetime, and owe no estate or gift tax. This means a married couple could gift almost $11M to their heirs and owe no estate or gift taxes.
Woman meeting with financial advisor in Danville, CA

While these concepts are important enough, they gain even more meaning when you factor in something called “discounted gifts.” The IRS also allows a thing called discounting, wherein a dollar may be worth less than a dollar when it comes to gifting. Allow me to illustrate this with an example:

  • Joe & Mary own 50% of ABC Manufacturing Co, an S corporation worth $50M. They own their shares inside of their revocable living trust and want to gift some of their shares to their kids for 2 reasons, first, so that their kids can eventually take over the family business, and second, so that their kids can start to receive some of the profits from the business now as they are in a lower tax bracket than Joe & Mary.
  • Let’s assume their shares are worth $25M (50% of $50M) and they want to gift 40% to their kids. That gift should be valued at $10M (40% of $25M) which means of their combined lifetime gift limit of $10.9M, they would have used $10M. However, this is where discounting comes in. The IRS allows Joe and Mary to discount the value of those shares by as much as 40% for things like lack of control, lack of marketability, etc. Let’s assume their CPA and estate tax attorney agree that in this case, a 30% discount is appropriate. That means their $10M gift only “costs” them $7M as far as their lifetime gifting limit is concerned.

The falling stock market is on everyone’s mind, as are fears of a recession in 2016. Just remember, while falling asset prices may not present a good time to sell assets, they do present a great time to gift them.