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By Scott Ditman, CPA/PFS, and Neil S. Lowenthal, JD, LLM,
David Berdon & Company Most people want to minimize their current tax liability and defer the
payment of taxes, thinking that the more taxes paid today, the less money
they will have for tomorrow. Yet under our estate and gift tax system,
deferring taxes, may not be the best strategy if the goal is to minimize
what you give to the government and maximize what your heirs will ultimately
receive. By making lifetime taxable gifts in excess of the unified credit amount
of $600,000, you can provide even more for your heirs. One reason is that
any post-gift income or future appreciation related to the property transferred
will not be subject to estate tax in the donor's estate. Another reason
is that if the donor lives at least three years from the date of the gift,
any gift tax paid is also removed from the estate, further reducing the
amount subject to estate taxes. Since the Federal estate tax climbs to
an imposing marginal rate of 55% on taxable estates over $3 million, making
taxable gifts may significantly increase the amount left for your beneficiaries.
Before making taxable gifts, there are certain planning opportunities
that should be fully exploited. One of the biggest tax breaks available
is giving up to $10,000 a year to any number of individuals without the
transfers being subject to gift tax‹as long as the gifts are considered
present interests. If the taxpayer's spouse joins in making the gifts,
the break doubles to $20,000 per donee. So, if a married couple has a child
who is married with three children, the couple could give away $100,000
a year ($20,000 per donee). Over 10 years, that would remove $1 million
from the couple's estate. In addition, any post-gift income and appreciation
related to the gifted assets would be removed from the estate and excluded
from estate taxes. An estate can be further reduced by paying the educational, or medical
expenses of any individual. These gifts are not subject to the $10,000/$20,000
annual exclusion limitation, as long as the payments are made directly
to the organization providing the service. Gift and estate taxes are structured under one system. So, in addition
to gifts covered by the annual exclusion, an individual can give away up
to $600,000 either during his or her lifetime or at death without triggering
Federal gift or estate tax. By making gifts in excess of $600,000 during your lifetime, heirs can
end up with even greater amounts after all taxes have been paid. The true
impact of what goes to taxes versus what is left for heirs is illustrated
in the examples below. Example No. 1: Mr. Greene, a widower, is considering making
a $2 million gift to his children. Assume that he is domiciled in New York
State and is in the highest Federal and state gift tax brackets. If he
gifts $2 million he will owe $1,520,000 of combined Federal and New York
State gift tax. Also, assume that Mr. Greene will live another 10 years
and that assets grow at an annual after-tax rate of 6%. As indicated in
the accompanying table, by making the $2 million gift, Mr. Greene will
have transferred additional wealth of $1,060,181 to his children. The longer
the donor lives after the gift is made and the greater the rate of return
on the gifted assets, the larger the amount of additional wealth the family
will receive. Mr. Greene has not only removed any post-gift income and future appreciation
from his estate, but also, since he survived the transfer by three years,
the $1,520,000 of gift tax that he paid is also out of the estate, further
reducing his estate tax liability. The key to this planning technique is
that the gift tax is calculated only on the amount that is actually transferred,
while the estate tax is computed on the entire estate, which includes the
portion of the estate that is used to pay the tax. Even though Mr. Greene
had to pay gift tax currently, he was able to transfer over $1 million
more to his children. Example No. 2: What would the results be if Mr. Greene
passed away within two years of making the gift? As shown in the Table,
if the taxpayer were to die within three years of making the gift, the
law requires an additional estate tax on the gift tax previously paid.
In determining the additional estate tax due, only the Federal gift tax
is subject to Federal estate tax and correspondingly, only the New York
State gift tax paid is subject to New York State estate tax. Even though
Mr. Greene passed away within three years of making the gift, he was still
able to transfer an additional $147,971 to his children. Making lifetime taxable gifts can be a tremendous planning opportunity.
No one likes to pay taxes before they have to, but by making gifts in excess
of the $600,000 exemption amount and paying gift taxes currently, an individual
can potentially pass on a significant amount of additional wealth to family
or other beneficiaries. However, planners need to consider proposed legislation
in the estate and gift tax area before implementing this strategy. * By Fredric J. Laffie Yesterday's insurance products were quite easy to understand. You had
a choice of whole life or term life. Today, we have annual renewable term,
guaranteed level term, universal life, variable universal life, variable
whole life, blended whole life and term, second-to-die (universal, variable,
whole life, and blends), and first-to-die written on a minimum of two lives.
In addition, there are hybrids of the above mentioned products. Can the consumers possibly understand what they are buying? Unfortunately,
more often than not, they are buying illusions. Variable life "illustrated"
at a 12% return or, even worse, on an historical basis or universal life
illustrated with assumptions that interest rates will increase in years
11 through 15, 16, through 21, and thereafter are just examples of what
is being presented by insurance agents. With the age of computers, the
agent can qualify as an illusionist, somewhat like Siegfried and Roy. Illusionists
make tigers disappear. Many products being sold today also will disappear
when you most need them! One major life insurer has decided that unless a policy illustration
"holds up" after reducing dividends by 11*2% they will not permit
the agent to make the sale. Unfortunately, when presented in a competitive
bidding war, the legitimate insurance professional is at a disadvantage.
Unless professionals such as CPAs and attorneys take a more active role
with the clients, more often than not, the proposed insured will probably
be duped or not truly understand the potential pitfalls of the products
purchased. Are all agents trying to fool the public? I believe the answer is no.
I also believe, however, that many agents are selling products that they
don't thoroughly understand. Is that as bad as duping a client? I'm not
sure, but the outcome could be similar! How many clients buy insurance as an "investment"? Great deal?
Wrong! How many individuals buy insurance and are told, "You only
pay ten premiums and the policy is paid in full." Wrong! Some policies
that have been sold this way will never vanish. There are some class action
suits against some major insurance carriers due to these misleading sales
practices. The September 18, 1995, issue of the National Underwriter correctly
points out that some policies purchased in the late 80s had projected to
pay premiums for 10 years "give or take a few years." The premiums
will end up being paid for as much as 30 years. This is due to significant
declining investment returns translating to reduced dividends. Unfortunately, the above scenario becomes magnified when whole life
contracts are aggressively blended with term insurance. These products
are like "mixing prescription drugs with alcohol." Keep in mind,
the more nonguaranteed term we mix with whole-life contracts, the more
sensitive these products become to dividend reductions. The reason people buy whole life is for the guarantees. If we are too
aggressive with the term blend, we might as well buy universal life, which
also lacks many guarantees but could be more flexible and have better loan
provisions. Recently, I was asked to review an existing policy that was sold when
dividends were quite high. The insureds are now over 70 years of age and
the surrendings of paid-up additions to pay for the term insurance portion
of this policy are inadequate. The insureds knew this could happen but
were told that they could increase the premium at any time. In New York
State, this particular product does not allow for additional monies to
be added, thus the insurance coverage will have to be reduced. These individuals
had thought they purchased $10 million of second-to-die insurance. At the
end of the year, however, the coverage will drop to about $8 million and
further drops could follow. Illusions, illusions, illusions‹a conservative approach is the answer.
As is an insurance professional who can explain the pitfalls of each product.
There are no perfect products. Insurance carriers ratings, dividend history
and mortality margins (death claim experience) should be reviewed. Even
with a reduced dividend scale, are mortality charges guaranteed? As a former practicing CPA and now an insurance specialist, I have seen
both sides of the coin. Caveat emptor! * Fredric J. Laffie, CPA, operates his own insurance firm in
Syosset, NY. Editors: Edward A. Slott, CPA Lawrence M. Lipoff, CEBS, CPA Frank G. Colella, JD, LLM, CPA Jerome Landau, JD, CPA Farrell, Fritz, Caemmerer, Cleary, Barnosky & Armentano, PC
James McEvoy, CPA JANUARY 1995 / THE CPA JOURNAL BENEFIT OF TAXABLE GIFTS Example 1 Example 2 10-year Scenario 2-year Scenario If $2 Million Gift If No Gift If $2 Million Gift If No Gift Current Value $3,520,000 3,520,000 $3,520,000 $3,520,000 Less: Gift Tax on the $2 Million Gift @ 76% Net Current Value 2,000,000 3,520,000 2,000,000 3,520,000 Net Current Value Less: Estate Tax @ 60% Subtotal 3,581,695 2,521,514 2,247,200 1,582,029 Less: Estate Tax Due to Addback of Gift Tax Paid: NYS ($2,000,000x21%)X21%) -- -- (88,000) -- Net Amounts Passing to Beneficiaries $3,581,695 $2,521,514 $1,730,000 $1,582,029 Additional Wealth Transferred by Making Gift $1,060,181 $147,971 JANUARY 1995 / THE CPA JOURNAL65
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