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- [00:00]
A
Foreign. What is up? And welcome back, everyone, to another episode of the Practical Planner Podcast. I'm your co host, Thomas Kopelman. Here with me again, David Haughton. David, really excited to dive into another episode with you and talk all things gifting. And so we're going to set the stage for all the ways that you can gift. And I think the most important place to start here is that you can gift more than $18,000. Right. I think everybody in our mind, and we were talking about this with some of, you know, the wealth people that are not necessarily on the estate side, they're more like marketing. And so this isn't like, obviously the deepest knowledge area of their life. And they're like, they've always thought their whole life that you could give $18,000 or it's taxable. And this is something that I hear literally every day when clients talk to me about is they think, okay, well, I can give 18,000, but if I give anything else, it's taxable. And at the end of the day, this isn't true. Right? So, like, if I'm married, you know, let's say I have one child, I could actually give 30, you know, 36,000 to that one child. If that child is married, then I could give 36 to the one child. We give 36 to the spouse. So, I mean, really, 72,000 a year, that can compound. That can go down to kids, but you also can give above that. Right. And so in today's episode, we're going to talk about different ways to do that. We. But also dispelling the idea that, like, if you give above it, this isn't a taxable thing unless you've already crossed that exemption, which we know 99% of people in the United States have not husband and wife given over $27.2 million. Right. They're nowhere even close. So if you do give more than that, the issue is in taxes, besides tax filing. Right. You obviously have to go file a gift tax return. You have to keep track of this exemption. But. But I could go give a million dollars today to my child that I don't have, and all that's gonna do is reduce that exemption amount, correct?
- [01:59]
B
That's correct. Yeah. Yeah. A lot of people hear the word gift tax and they think if they give too much, they're going to get taxed. And there's so much nuance to it because, yes, it's what's called a taxable gift, but you have an exemption up to the estate tax exemption, which is 13.61 million per person, double for a married couple. So by the time you're going to hit that, it's going to really, really take a large estate. And if you're at that level of estate, you're probably going to have some sophisticated planning to make sure that you're careful about how you're gifting. So certainly something to be cognizant of. You don't want to have to file a gift tax return if you don't have to. So it's good to know the different ways to gift that you can avoid that having that hassle necessarily. And, you know, it's a good thing certainly to preserve your estate tax exemption if you don't have to use it. But if you're in a situation where you want to give more than $18,000, you're nowhere near any situation where you think you're going to have a estate tax issue either now or at potential sunset, then you're probably okay to just give the gift and then file the gift tax return.
- [03:16]
A
Yeah, no, totally agree. So I think there's like two parts of this episode I really want to hit on. I think, you know, we've talked in previous episodes about exemptions being cut in half and all these things, but in today, I think we should talk about one ways to gift and then we can maybe talk about, you know, some other unique strategies that exist. And maybe I do one, you do one, and then we just keep hitting on them. And so I think one way that I think about it, besides just, you know, let's give $18,000 a year, is you can really help your, your kids in many ways. One of them can be school, right? So for school, you can basically pay an unlimited amount that exists in that year without having to use any of your exemption. But you also can plan for college and do more than $18,000 a year. So something about my client base is a lot of my clients are very high income earners. We whether that's, hey, we make a ton at our W2 job or we own a business. And a lot of them are, hey, this is, I'm going to have this for five years to 10 years, but I don't know how long it's going to last. And so I want to get a lot of my saving and investing done when my income is this high. And so one thing that we always look into is super funding a 529 plan, right? So you can basically give 18,000 times five and then double if you're married, right? So about $180,000 you could give this year into a 529 plan without using any of your exemption. The big thing here then is for the next five years, you can't give any more unless the exemption goes up. Right. So if next year goes to 20, the next year goes to 21. That added amount you can slowly contribute in, but in general you can't do more than that unless you want to use some of your exemption.
- [04:52]
B
Right? Yeah. And you know, that's a really, really powerful tool. Obviously you have to survive the five years to be able to use all five years. The other thing that's really important to know that strategies is you do have to file a gift tax return. If you do that, even though you're staying under the exemption, you have to file it and elect it. And you know, it can get a little complicated too if you don't do the full super funds. So you don't do the 18,000 times five. Let's say you do 50,000 over five years. Now you're in a situation where you're using 10,000 per year. So really, really powerful tool. You just got to make sure that you know the implications of it and you keep the accounting of it, obviously.
- [05:34]
A
Yeah, really good point. Okay, what's the next one that comes to mind for you?
- [05:38]
B
Well, you know, we talk about gifting as far as gift tax returns, taxable gifts, staying under the limits. But there are ways that, that you can gift and they might be the reason that you were gifting anyways, but avoid needing to file the gift tax return. And two big things that jump to mind you, you kind of hit on it briefly is paying for college. If you actually pay directly for tuition, that is a tax free gift, that's not going to even impact your $18,000 annual exemption. So if you pay directly for college tuition, that is something that would kind of fly under the radar, so to speak. Obviously, you know, keep receipts for if the IRS comes knocking, but it shouldn't need to be reported. And then another one is for medical expenses. If you pay directly to the hospital for someone's medical expenses, that's another thing that is not going to affect your $18,000 limit. So if you were going to give to somebody for those purposes, it could be a good idea to look into. Well, maybe there's a way to give directly to the institution or to the hospital and avoid any of these issues regarding taxes.
- [06:56]
A
And that can be for anybody. It doesn't just have to be dependents, it can be for anybody. And you do that right?
- [07:02]
B
Yes.
- [07:03]
A
Okay, perfect. Okay. Well, the next one that comes to my mind that actually happens with a lot of my clients is they live in high cost of living areas. You know, even if they make a lot of income, it's still pretty unaffordable to buy in, let's say New York or you know, nice areas of California. Parents are wealthy, parents really want their kids to stay there, so they're willing to help in the house in some capacity. That could be down payment, that could be the full amount. And so there's a few strategies here, right? You could either gift the down payment and use some of your exemption, depending on the amount. You could, you know, give over a few years so that they could afford the down payment, potentially not use the exemption, potentially use it, or you could let them borrow. Right. And so that's a really common strategy that high net worth households do is they say, hey, we can borrow, we can have an agreement at AFR rates. And I think I was looking the other day when I was talking about this with a client and maybe over a 10 year loan was like 4.4% or something like that. Don't, don't quote me something around there. But let's say, well, but you know, that can be really impactful if you, if you, you know, $1 million, 4.4%, you could structure interest only loan, you know, amortized loan, you could do whatever. But in the grand scheme of things, you also might be able to forgive the interest on that loan on a yearly basis without using any exemption. So I think that's a strategy that comes to mind for me a lot because it gives a lot of flexibility. So it gives flexibility for the children to, hey, if things are tough, parents can forgive it. And if things are good for the parents, the parents can forgive it. But if something happens and the parents are struggling, then they can say, well, hey, we can't really keep forgiving this for X number of years. We do need you to pay us back. And you have that flexibility.
- [08:44]
B
Yeah, absolutely. And you know, it really, really critical that they stick to the formalities of the intra family loan rules. As you said, a lot of people don't do that.
- [08:53]
A
So that's really important. Nobody does.
- [08:56]
B
No, no, they do not do that. So you got to look at what that rate is. But you know, with the mortgage rates right now, you know, this is a really popular way to go, right, because you can save so much money by paying a family member rather than paying a mortgage company. But you know, you got to make sure that you follow the formalities, they can forgive it. As time goes on, make sure that there's nothing, you know, there is no pre arranged circumstance where that's how it was going to be set up because then the IRS could say it was all smoke and mirrors and it's all a gift because you never really intended for this to be a real loan transaction. So obviously the other thing is make sure that you have a document, you know, memorializing the terms of it so that if anyone needs to take a look, you have all those formalities. But if you do all that, then you can avoid it being a gift and you can really help in a big way. The other thing I would want to mention about that that's important though that some people forget is when you're paying the interest that's going to be income to the recipient, so they may potentially have to be reporting that on their income tax returns. So that's just another important aspect to.
- [10:09]
A
Remember that is important. I actually nobody I've talked to has really brought that up. I mean, obviously it makes sense, right? They're doing a loan, they're generating income. And this is something that works pretty well, right, Because AFR rates pretty similar to yields you're going to get on cash. So instead of kids having to pay way higher interest rate loans, parents can actually kind of have an equilibrium of the opportunity costs of what would happen there if they do want the interest back. But you end up borrowing quite a bit less, which is a huge thing over 10, 20, 30 or large loans.
- [10:38]
B
Right.
- [10:38]
A
I think for me, you know, there's there's just other like full gifting strategies, whether that is, you know, gifting ownership in a business, whether that's gifting a house. And you know, I have people who, they end up giving assets, you know, they own. You know, one of my friends, actually his grandparent gave him, you know, quite a bit of money in Apple stock. And you know, I think these are interesting things like of course if they have a need at that time that can be beneficial to help. But you do lose a lot of the tax benefits by gifting while alive versus when you pass away and getting that step up in cost basis. And you know, my friend just had it and I was like, gosh, I mean like not to be morbid, your grandparents are in pretty like they don't have a lot of life expectancy left. You have $90,000 of embedded gains in this gift versus what would have ended up being a step up in cost basis. And you could make some have easier Decisions to make from that.
- [11:31]
B
Yeah, absolutely. Yeah. I mean that's, that's so critical is to, to look at what the asset is, what you're gifting, why you're gifting it, and what the implications of it. If you're going to lose a step up in basis when you could find an asset that had more of a flat basis or cash, usually it's better to give the cash, you know, unless, unless you're looking to avoid the gain yourself and you know, pass it along.
- [11:55]
A
That's true.
- [11:56]
B
You know, that could be a scenario too. The other thing is, you know, if you're gifting business interests, especially if you're high net worth, you know, there are a lot of strategies involved there where you can gift the business interest at a discount. So if I'm giving away a million dollar interest in a closely held business that I have to a child, I might be able to gift that away for 75 cents on the dollar. As far as what I'm using in my estate tax exemption by doing some of the little bit more complex and some of the strategies that require some maintenance. So that can be a really, really great strategy to get a business interest out of the estate at a discount without using a lot of your estate tax exemption. Yeah, you got to be extremely, extremely careful with that. And I have a, I have a brief story. I had a client and this is actually a story of why the advisor is so critical to the estate planning process and they should be involved in the estate planning process. I had a client who was a doctor, they owned a lot of rental property and they came in to set up an estate plan that was going to save on estate taxes, especially state to state taxes. And so there was this family limited partnership, really complex strategy that came up to transition the business to a child at a discount. And it would go over a number of years. Well, we set up with all the documents, changed all, you know, the beneficiary designations on LLCs and all kinds of things to accomplish this. And about a year later he came in and he hadn't done anything the way that he was supposed to. He was depositing checks from the rent directly into his individual account, was not following any of the formalities of the strategy. And so as far as the IRS is concerned, that was pretty much smoke and mirrors. And why I say that the advisor was so important is that later on I talked to the advisor and they hadn't been a part of the process, they weren't brought on in the beginning. And, and the advisor said he was never going to follow through with that. I know him. You should have done something less complex, less sophisticated that he would have followed through on. And that's really, really, really important information. Right. Because the advisor knew the client so well over years of annual meetings. Whereas, you know, in the estate planning process, sometimes the attorney meets for a couple hours. They don't really know the client that well. And you know, behaviorally, family dynamics, what have you. So some of these complex gifting strategies can be really powerful, but you got to be really, really careful that you're doing it. Right.
- [14:36]
A
Yeah. And the other thing too is like, let's say the client was maybe a better one. They could do this, but you know, they're busy. Right. Like most of my clients, I would say it takes double digit reminders before they do their estate planning, before they set up the meeting, whatever. And like that's just the reality. Right. People are busy, they have a lot going on. Like, sure, it might feel super important to us, but to them it's like, oh, that's a task I gotta get done. And so as the advisor, you can drive the. Like I tell my clients I will relentlessly follow up with you every two weeks. Like, have you started your estate plan? I'll send them the reminder through wealth or you know, reconnect them with the estate planning attorney. And I think eventually you're gonna hit them right at that time where they have, they're free and they're gonna actually go do it. And you know, that's a, we all know accountability is a really impactful part of, you know, working with professionals. But that's also funny because I have, you know, I have a new client starting where I have siblings, dad owns a great business and we're thinking through the gifting strategies of how to move the business down. Dad's very wealthy, he's not involved, doesn't really want to be in the business anymore. And you know, you brought up the, you know, for 75 cents on the dollar. Yeah, that's what I've always heard. Somewhere between like, you know, 65, most often like 70 to 75%. So you can get a pretty good discount giving it to family. And even though the step up in cost basis thing I talked about, that's great, but not if the parent doesn't want to be involved and it's 30 more years, you know, they're young, in pretty good shape and healthy. Like, there are times where that does make sense. The only other thing that I can really think of without like going super Deep into, you know, irrevocable trust strategies is gifting with irrevocable trust in general. Right. I mean, that could be grats, it could be a ton of different trusts. And I think a lot of times advisors and other people think, unless you're gonna use all of the exemption, why give? And I think there is a really big reason why, and it's because of growth. Right. We all talk about, as advisors, the impact of investing early. And so I was having this conversation earlier with a client and like, you know, they're about 20 million net worth. They're not in a situation to give all the exemption even on one spouse. They're young. There's a lot of things that they want to do, but they have a lot of equity in a really growing company. And maybe you're not going to use all 13 million, but even if you move 1 million, right, and you're in your 30s for your child, that could be worth 5, 10 million down the line, even though you only used 1 million of an exemption. So I think people get so caught up in using the whole exemption, they actually don't think about the growth that comes out of the estate, which is maybe one of the most impactful parts.
- [17:07]
B
Absolutely. Yeah, that's, I mean, that's, that's a major part estate planning, estate tax planning, especially for someone who's younger and who, you know, is going to be acquiring wealth as they go along, their estate's going to grow. And there's just so many strategies out there that are designed to get the growth out of the estate. Not necessarily. You know, you talked about Gratz. You know, the idea behind that is to get the growth out of the estate by investing and, you know, beating the, the, the interest rate. And so, you know, all those strategies, they can get complex, but they can have such power because, you know, there's a 40% estate tax rate and to whatever extent you can mitigate that is incredible. The other thing that I would mention is, you know, if you're gifting to a trust and it's outside of your estate, but it's what's called a grantor trust. And so that's a trust where you are the taxpayer, right? So even though it's an irrevocable trust, even though it's outside of your estate, any income generated in that trust is taxable to you as the settlor, even if it hasn't been distributed, even if the income is accumulating within the trust. And so why that is good is, number one, you know, the Trust in the state's tax rates are really, really high. So it's much better to usually pay taxes at your own rate rather than the really unfavorable trust and estate tax rates. But the other really powerful strategy that's a part of that is that if, if the trust generates income and you're paying taxes on that income from personal assets, you're actually getting more assets out of your estate without it being a gift at all because it's your tax liability. So we call that a tax burn. So there's a lot of different benefits to gifting into irrevocable trusts.
- [19:03]
A
Yeah, I love it. Last one I'm going to hit on before we close out is just having life insurance. Right. I mean this is a pretty simple one. Obviously there's eyelets that you know for estate taxes. There's also eyelets for larger gifts. But in general, even just having either a permanent policy or a term policy that has, hey, I want to make sure that I give a million to each child or I give, you know, 250 grand every grandchild. Right. You can just simply have a life insurance policy, know the exact benefit you're going to get. So that way you can give exact gift amounts. I think the only thing we didn't really hit on is like charitable giving, but that's like such a deep topic that, you know, I think we'll go into later. But you know, estate taxes are really important. I have a conversation with a client yesterday. They're about 40 million net worth, in their 30s, mid-30s, he's a founder of a pretty great company and they're not going to have any kids. And so we had a conversation really on estate taxes. What they're thinking there and their mindset is they're going to try to approach Daiwa Zero as close as they can. Every dollar that they have is going to charity anyways. They know they're going to have an estate tax issue because they can't spend based on what they're going to have. But when you know you're just going to give to charity, either everything over exemption or just everything in general that can help, you know, that is just another gifting strategy.
- [20:15]
B
Yeah, yeah. It makes things so much easier. I mean, and just to on top of that, the other thing is when you're doing charitable giving, if you're giving to something like a donor advised fund, that's a situation where actually I see as a really powerful tool, if you bring in the next generation to actually get them involved in charitable giving was something that they can never take back. So it's something they can manage, something that they can pick the organizations to give from, kind of like a family foundation without all the costs and. And administration. That's really a great tool as well.
- [20:50]
A
Yeah. Yeah. Okay. Perfect. Well, David, thanks again for hopping on with me. I'm excited to do more episodes with you later this year. And everybody, thank you again for listening and tuning in. And again, we said in the last episode, if you have any questions you want us to answer, feel free to send us an email. We'll be checking those out. And then please rate and subscribe, and we'll see you back in a couple weeks.