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Maximizing Estate Tax Planning Through Annual Gifts, and Unlimited, Direct Gifts of Tuition and Medical Expenses

Can your family benefit from annual gifts, gifts of tuition or gifts of medical expenses? Under the American Taxpayer Relief Act that was passed into law on Jan. 2, 2013, the federal gift and estate tax exemption was set at $5.25 million for 2013, indexed to increase with inflation thereafter. In simplified terms, this means that an individual can make gifts during life, added together with bequests made at death, up to the exemption amount without triggering any federal gift or estate taxes. However, all lifetime gifts plus bequests-at-death that exceed the exemption amount will be taxed at 40 percent

Not just for the extremely wealthy

On its face, $5.25 million may seem like a substantial amount that would interest only very high net worth individuals to engage in careful gift and estate tax planning. But several factors should cause individuals of more modest wealth to think again. First, this federal tax framework is subject to legislative change at any time, and a future change in the law could reduce the amount of the exemption – perhaps substantially.

Second, many people are unaware that life insurance proceeds will generally count towards the exemption amount. Third, many states have their own state estate or inheritance tax which provide for far lower exemption amounts. Indiana is in the process of phasing out its inheritance tax, but it remains an important consideration during the phase-out period and, of course, Indiana’s estate tax could be reinstated with future legislation.

What are exclusions?

One of the most basic and important estate tax planning tools is making the most of “exclusions.” Exclusions are gifts that are not taxable, nor charged against the donor’s lifetime use of the exemption amount. This year’s federal gift tax law retained the “annual exclusion,” which has been set at $14,000 for 2013. This means that one may gift up to $14,000 to as many individuals as desired -- children, grandchildren, spouses of relatives, and even unrelated third parties -- without triggering any gift tax, using up any of the lifetime exemption, or even needing to file a gift tax return. (And, the $14,000 can be effectively doubled to $28,000 per recipient if married spouses both take advantage of the annual exclusion.)

For individuals who can afford to part with this money or property (e.g. life insurance ownership or limited partnership interest), it removes the value from their estate entirely, which has added potential leverage given that the $14,000 might appreciate substantially if held by the donee until the donor's death. While many individuals are already aware of the annual exclusion and take advantage of its tax planning benefits, less are aware of other valuable exclusions.

Exclusion for tuition

The first additional exclusion covers qualified gifts for tuition. This means that, in addition to, or instead of, making annual exclusion gifts, the donor can pay tuition expenses of the donee(s). There is no limit to the amount. The gift can be for tuition for university, or private high schools or primary schools (but not camps or day care facilities). Thus, grandparents, for example, who pay for their grandchildren’s education are able to transfer what is potentially a significant amount of money to future generations, tax free. Gifts of tuition have the added benefit that, unlike a $14,000 cash gift made per the annual exclusion, the donor knows precisely how the money will be used.

To qualify, there is some fine print. The tuition exclusion applies only to tuition costs, and not to non-tuition expenses such as books, supplies, or room and board. Second, the tuition must be paid by the donor directly to the educational institution – not indirectly, such as a gift to the student who then pays the tuition. Gifts to reimburse for tuition paid previously also do not qualify. Nor may the tuition payments be routed by the donor through a trust.

In addition, to be a qualified educational institution, the school must meet certain basic requirements, like maintaining a regular faculty and curriculum. Any tuition gifts contemplated to unconventional institutions should be discussed in advance with a tax planner to determine qualification.

Exclusion for medical expenses

Another gift tax exclusion applies to the payment of another's medical expenses. Again, these payments must be made by the donor directly to the medical provider. The donor’s payment of medical insurance premiums on behalf of the donee qualifies for the exclusion. Reimbursements of medical bills that have already been paid do not qualify, nor do payments to providers which will ultimately be covered and reimbursed by insurance. In addition, the nature of the medical expenses must be “qualified,” but this generally includes payments to doctors, dentists, psychologists, hospitals, inpatient alcohol/drug treatment, prescription medications, prescription contact lenses and eyeglasses, etc. Most cosmetic surgery and over-the-counter medicines do not qualify. Again, any contemplated gifts for medical care should be discussed in advance with a tax planner to determine qualification.

Prudent use of the annual exclusion, coupled with qualified tuition and medical expense gifts, are important but often underutilized tools that not only reduce estate taxes, but in the process can substantially improve the education and health care of the recipients of these gifts.

DISCLOSURE REQUIRED BY CIRCULAR 230. This Disclosure may be required by Circular 230 issued by the Department of Treasury and the Internal Revenue Service. If this article, including any attachments, contains any federal tax advice, such advice is not intended or written by the practitioner to be used, and it may not be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. Furthermore, any federal tax advice herein (including any attachment hereto) may not be used or referred to in promoting, marketing or recommending a transaction or arrangement to another party. Further information concerning this disclosure, and the reasons for such disclosure, may be obtained upon request from the author of this article. Thank you.

  • Partner

    Greg works with estate and wealth transfer and matrimonial law in the firm's Estate Planning Department and is also part of the Corporate Services Department. Among the legal services he provides for his clients are estate and gift ...

  • Partner

    Mike is a partner in Bingham Greenebaum Doll LLP’s Estate Planning Department. The Estate Planning Department seamlessly coordinates and executes a wide array of legal services that cater to the unique needs of high ...

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