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October 11, 2003: Gifting Pitfalls

Q: What are the problems associated with gifting?

A: Although I have recently written on this subject, in the current series on common problems in estate planning, this area of concern needs to be revisited at this point.

A brief review of the general rules seems helpful at the outset. A person can gift tax-free $11,000 of value per person per year. There is no limit on the number of annual gifts to different people or how many times the annual amount is used through the years.

Remember the period is for a calendar year, so it is a total of all transfers made during the year. Transfers such as birthday, Christmas and other presents must be included, along with such things as meals and those $10 bills that grandmother gives to each grandchild for visiting her.

If one person transfers more than $11,000 during any calendar year, then the giver must pay tax amounting to approximately 50% of the amount exceeding the $11,000 limit. The receiver does not have to pay gift tax and the amounts are not included in the receiver's income totals.

To avoid paying gift taxes on the excess over $11,000, an informational tax return must be filed with the state and federal governments subtracting the excess over $11,000 from the estate tax exemption amount, currently at $1,000,000.

To constitute a gift, a transfer in ownership must occur. Thus, such things as adding a name to a bank account or to a deed constitute a gift, triggering a possible tax based on the percentage of the net value of the asset over $11,000.

But what are the problems? First, a gift is a gift and once transferred, the giver has no right to get it back. In fact, the receiver would have to voluntarily return ownership and face the same tax restrictions and problems just mentioned for the original giver. What happens if the receiver dies, is involved in a divorce, or experiences financial problems.

With the estate tax exemption at $1,000,000, gifts usually do not have to be made in order to "keep the government from taking everything in taxes" and in Colorado, through the presence of unsupervised administration for settling estates, gifting does not necessarily "make it easier to settle my estate."

If a gift is made, appreciated assets should not be used. If gifted, the receiver will take over the basis (what was paid for the asset or the value at the time the asset was inherited by the giver) so that the same amount of capital gains would be paid when the asset sold, whether by the giver if the transfer had not been made or the receiver after the transfer.

But if the asset is retained and not gifted but then inherited, the receiver would obtain a new, "stepped-up" basis to its then value at the date of death and would pay no tax if the asset was sold at the date-of-death value regardless of the original basis. Thus the reason for the old rule of thumb that it is better to inherit rather than having assets gifted.

Often gifts are considered because of fear that future medical and health care bills might wipe out all assets. Unless a nursing home experience is obviously right ahead, transfers are ill advised for all the previously reasons outlined. Plus to be effective, the single "transferor" would need to "impoverish" him or herself for three years unless the transfers were made to an irrevocable trust, thus extending the time from three years to five years before the giver could qualify for Medicaid.

But beware because social services keeps adjusting the rules, so a transfer now may be exactly the wrong strategy or unnecessary in the immediate future and the running of the 3-year (or 5-year) waiting period could prove meaningless or even harmful for the reasons indicated in this column.

And even though the transfers were exempt from gift taxes (under $11,000 per person per year or subtracted from the current $1,000,000 exemption), for Medicaid qualification purposes, three years must still run. Otherwise the giver would not qualify.

Sorry, I have run out of space and must stop.

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