By Attorney Paul T. Czepiga, JD, CPA

People have a tendency to hold on to things that they will never use - old newspapers, a glove for which they have lost the mate, or money. Yes, money. Why? The reason is always the same: "Because I may need it someday." But whereas holding on to some old newspapers or an unmated glove does not cost anything, holding on to money you don't need can cost plenty. Let's explore this below.

As an estate and tax planning attorney, I am always looking for ways to save my clients from having to pay more gift and estate taxes than is necessary. One of the simplest ways to reduce these taxes is to make annual exclusion gifts of $10,000 or less each year to as many beneficiaries as you would like. Most people are familiar with this strategy. Under the Internal Revenue Code, there is a gift tax with effective rates ranging from 37% to 55%. As an exception to the imposition of these taxes, however, the IRS allows each person to each year make tax exempt gifts of $10,000 or less to as many people as they care to. A married couple, for example, with four married children could give away $20,000 to each child and to each in-law, if so inclined, for a total of $160,000 per year (mom and dad to each child and to that child's spouse = $40,000 per child and spouse x 4). In most cases, this can be done without the need to file gift tax returns. Because gifts are not income, the recipients are happy to receive whatever your client may wish to give them. For someone in a 40% estate and gift tax bracket, giving away $40,000 has just saved $16,000 that goes to your client's beneficiaries instead of to the IRS. A client does not have to do this every year to make it worthwhile.

Many people, however, feel constrained by the $10,000 annual exclusion amount and believe that they either cannot or should not give more than $10,000 to any one person in any given year. In addition, many people are reluctant to part with money that, from an objective third party's viewpoint, the person will never ever need. Usually, the client admits that they probably won't ever have need of this "extra money" but, because there is a possibility, no matter how remote or unlikely, that it might be needed, they keep it. The result is costly from a transfer tax viewpoint. Generally, if your client is relatively certain that they don't now and won't in the future have need of a portion of their money, then they should give away some or all of the excess even if they use up a portion of their unified credit or incur gift taxes and must pay the IRS "out of pocket!" This is the best economic outcome. An example will illustrate this.

Let's assume that Mr. and Mrs. Jones have scrutinized their current finances and likely future scenarios regarding all aspects of their personal lifestyle, financial needs and available resources and have concluded that they have $200,000 that they can do without. Let's assume, as well, a ten year life expectancy for the Jones', a 10% rate of return on their assets, and that they are in a 45% estate and gift tax bracket. If they retain the $200,000 it will have grown to $518,000 at their deaths ten years from now and they will have to pay 45% of this, or $233,000, to the IRS in estate taxes. Their children will receive the remaining $285,000.

What if, instead, the Jones' made a gift of the money now in a fully taxable transfer (having previously used up their unified credit and their $10,000 annual exclusions for that year). What result? Remember, the Jones' are only willing to part with $200,000 in total. The Jones' can, therefore, give away by way of a taxable gift $138,000, using the other $62,000 to pay the 45% gift tax on the $138,000 gift. Assume that the children invest the net gift of $138,000 at the same 10% rate of return their parents would have earned had they retained it. Now, at the end of ten years, the children have $357,420. None of this is taxable in the parents' estate because the parents gave it away 10 years ago and paid, at that time, a $62,000 gift tax for the privilege of doing so. Good economic decision? Ask the children. They are $72,420 dollars better off with mom and dad paying gift tax now instead of holding on to the $200,000 of "extra money" until they died and paying estate tax at that time.

What was the cost to mom and dad? Nothing, really. Remember, the $200,000 was money that mom and dad agreed they would never need under any foreseeable scenario. They won't miss it. This example does not take into account the emotional issues that are part of this-are the children mature enough to handle the money? Are they deserving? Will they do with the money what you hope they will do? Where will the money end up if they get divorced?, etc. These issues, however, can be addressed in any given situation.

In addition, there are income tax issues associated with the sale of gifted assets if the assets had a low basis in the hands of the donor. The selection, therefore, of what assets to gift becomes important, but it does not mean assets should not be gifted in the first instance. Even a gift of low basis assets is advisable if the capital gains rate for the donee is substantially less than the estate tax bracket of the donor or if the assets are not going to be sold by the donee. Although contrary to what many people may first think, paying gift tax when not compelled to do so makes good economic sense from a multi-generational wealth transfer viewpoint. The donee ends up with more money, the donor will not miss what they never used or needed anyway, and the IRS doesn't get more than it should!