Market Overview

Guest Column: Annual Gift Exclusions Offer Tax Benefits

George Young, porfolio manager of the Villere Balanced Fund (VILLX), shares his insights on year-end giving.

We all know about the looming fiscal cliff and the vagaries of the tax code. Even if you have a faint grasp of how the code works today, much of that could be rendered moot by year-end as Congress and President Obama endeavor to craft a compromise over expiring tax breaks and revenue increases.


However, the annual gift exclusion remains available. Many investors with significant amounts of assets have employed this technique successfully for years, to benefit friends and relatives and remove assets from their estate. Besides the gift tax, individuals can gift money for educational and medical expenses in addition to the gift tax exclusion.


These are methods by which high net worth individuals can reduce the value of their estates, potentially escaping future estate taxes. While parents frequently take advantage of these provisions to gift money to their children and grandchildren, anyone can gift these monies to a relative or friend and move funds out of their estates.


Estate Tax Implications
Taking advantage of tax provisions that can reduce the value of an estate is important given the fiscal cliff issue since there is a possibility that estate tax limits will revert to their pre-Bush tax cut status. This year, the estate tax impacts estates valued at more than $5 million; such estates are subject to a 35 percent tax rate. If the Bush tax cuts expire, which would happen if no action is taken by Congress and the President to avert the fiscal cliff, estates valued at more than $1 million would be taxed at a 55 percent tax rate. Previously, the Obama administration floated a compromise whereby estates exceeding $3.5 million would be taxed at a 45 percent tax rate.
Regardless of what happens, it’s pretty likely that the estate tax will not stay as favorable as it is today, so high net worth individuals can use the gift exclusion and medical expense and tuition gifting provisions to move money out of their estate that might otherwise be subject to the estate tax in the future. Even if the fiscal cliff negotiations result in a favorable outcome to the estate tax, rising budget deficits make it likely that the estate tax will impact more high net worth families in the future, so it makes sense for high net worth individuals and couples to do everything they can to reduce their taxable estates.


Gift Tax Exclusion Specifics
Here are the specifics of the annual gift exclusion: every year you can make a tax-free gift to anyone. In 2012, this amount is $13,000; next year, the amount increases to $14,000. Individuals can give multiple gifts to different parties; a couple can each give up to $14,000 to a child or grandchild or another individual.


Here’s an example of how that might work: two parents use the exclusion to gift funds to their three children. For 2013, each parent would give $14,000 to each child, for an individual total of $42,000. Together, that gift would add up to $84,000, reducing the parents’ estate by that amount.
For a multi-million estate, that may not sound like much, but when gifts are made every year and made to more individuals, it can add up to a significant amount. In this economy, many parents and grandparents can use this to help relatives who need help because of lost jobs or cuts in financial aid.


While some financial advisors recommend gifting appreciated property such as real estate, coins or securities, the value of the gift to the recipient is actually less than anticipated because of  the tax that the recipient would have to pay when selling those assets. Instead, it’s wiser for the donor to sell the appreciated assets, pay the tax now – which for investments is at a historically low 15 percent in 2012 – and give the cash to the recipients.


Medical & Tuition Gifts
Individuals can also take advantage of provisions involving gifts of medical expenses and tuition above and beyond the $14,000 gift exclusion. The IRS allows individuals to pay medical expenses directly to a provider on behalf of a relative, friend or other third party without any tax being due. Those expenses must not be reimbursed by insurance or the gift is taxable. If the gift is made directly to the person incurring the medical expenses rather than the medical provider, that will count towards the gift tax exclusion, so make sure to pay the provider directly.


Similarly, individuals can pay tuition expenses for a relative, friend or other third party as long as those payments are made directly to a qualified educational institution. The IRS provides more information about Qualified Educational Institutions in Publication 970. Generally, most accredited community colleges and four-year colleges are qualified. Only tuition meets this exclusion; room, board and fees don’t meet the qualified educational institution test. You can pay tuition up to the full amount charged by that institution.


A Final Word
These exclusions are useful for high net worth individuals seeking to reduce the size of their future estate for tax purposes. Adding the gift exclusion with the medical and tuition gift exclusion means that a sizeable amount of funds can be removed from an estate in a given year.


These gifting techniques have been available for some time so it’s a safe bet that you can use this again in 2014. Please don’t forget that the end of the year is coming and the window of opportunity is about to close on 2012. Even if you haven’t made gifts before, you can make the gift now and then make another gift on Jan. 1, 2013.

 

George Young is the co- portfolio manager of the Villere Balanced Fund (VILLX), based in New Orleans.  The fund received a 5 star Overall Morningstar Rating among 771 Moderate Allocation Funds for the period ending 9/30/2012 (derived from a weighted average of the fund’s three-, five- and ten-year risk adjusted return measure, if applicable) . The fund ranked in the top 2% for 1-year among 892 funds, 1% for 3-years among 771 funds, 1% for 5-years among 670 funds and 1% for 10-years among 381 funds in the Moderate Allocation category based on total returns for the period ending 9/30/2012.

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