Maximizing Gift Tax Exclusion 2009

[Martin Hash]

In the modern political climate and into the foreseeable future, ostentatious displays of wealth is something you will want to avoid. Combine that with the current depressed stock valuations plus the impending tax increases, now is the time to create trusts for your heirs. For “wealthy” families, (defined politically as over $250K/year income), tax management will be essential. Because of the devaluation of many investment portfolios, especially ones yielding high dividends, transferring those low-priced stocks to an beneficiary that is in a lower tax bracket maximizes the number of securities that qualify for your Gift Tax exclusion, and minimizes the tax rate on the dividend income, (because, presumably, the beneficiary is in a non-wealthy tax bracket.)

Trusts can seem complicated but that is because attorneys try to provide for every eventuality, otherwise they may be held liable for any oversight that results in a non-optimum outcome for their clients. You, however, are under no such expectation, and unless a trust is challenged it will usually be implemented as written, and the vast majority of trusts are not challenged. The other concern of writing a trust yourself is that only irrevocable trusts can obtain the tax advantages mentioned here, so you must be certain that the gift is exactly as and how you want it before publication, (meaning the trust is signed in duplicate in front of a notary public).

Here is an example:
You have a child and a portfolio of high-yield (20%+) stocks and bonds. (You probably bought the securities when they yielded 7% but then the market collapsed and your $30/share fell to $10.) When you transfer those shares to your child, their value is the low $10, so three times as many shares fall under the $1,000,000 Gift Tax exclusion. Plus, assuming those stocks increase back to their original price in the future, the beneficiary will only be liable for Capital Gains on the increase over the Settlor’s basis, the original $30.

Write a declaration giving shares of stock to your child – the number of shares depends on how much yearly dividend income you wish your child to receive, and pay taxes on. Include the market price at the day of the gift – this will be the amount of Gift Tax exclusion consumed - and also record the original cost for capital gains purposes later on when your child sells the stock. The gift must be irrevocable for the federal tax purposes, so use the word “irrevocable” in the declaration. Determine how you want the earnings and corpus (principle) distributed. For example, you might want the dividends to go to your child but hold back the corpus until the child is of mature age (35?). Make yourself the trustee. At year’s end, the dividends are included in your child’s gross income. Be aware that in this market, many dividend stocks are paying out of their equity (which will be listed on the 1099-Dividend report you will receive for the end of the year), so do not include that amount. Plus, watch for Foreign Tax paid because is most cases you can take those as a credit.

This is not a situation you would normally wish to be in – a stock losing two thirds of its value, but when life gives you lemons, make lemonade. Assuming your stocks will eventually regain their value, you will have actually used the current devaluation to your advantage.

Dr. Martin D. Hash, Esq. is a Washington State attorney and accountant. He can be contacted at martin@hash.com