Gifts made to charities during your lifetime qualify for income tax deductions. Gifts made at your death to charities reduce your taxable estate because gifts made to charities are not subject to estate taxes. For example, if you left all of your assets to a charity at your death, regardless of the size of your estate, there would be no estate taxes.
In addition to the gifts discussed above, you may give away up to $5 Million in gifts during your lifetime without paying a gift tax if the gifts are made in 2011 and 2012. Lifetime gifts in excess of $5 Million in 2011 and 2012 require payment of gift taxes, which may be worthwhile in terms of the overall estate and gift tax planning you are doing. The $5 Million amount will revert to $1 Million for 2013 and future years, unless Congress enacts new estate tax legislation.
This $5 Million is known as the gift tax exemption amount (GTEA). This gift can be split over several beneficiaries, but it is not $5 Million per beneficiary.
If you have an asset that you expect to grow in value, gifting the asset while using your GTEA will allow you to keep all the future appreciation out of your estate for estate tax purposes. For example, if you own $100,000 of stock in a company and the value of this stock is expected to be $1 Million in two years, gifting the stock today to your children can allow you to exclude the $900,000 increase in value from any transfer taxes (whether gift taxes or estate taxes).
If you want to make gifts to children, but do not want your children to have control of the money (e.g., they are minors or financially irresponsible), you can set up a trust to be the recipient of the annual gifts on behalf of your children and have a trustee control the distribution of income to your children.
The major disadvantages of annual gifting are that the gifted asset is no longer available for your needs, and you lose control over the asset and its value. Within these parameters, though, annual giving (coupled with the unlimited exclusions from gift tax for medical and educational expenses) represents a simple and flexible planning technique available to nearly every person with a taxable estate.
If you have an asset that is not producing income, or not as much income as you would like, you can establish a charitable trust and transfer the asset to the trust. You would receive an income tax deduction for the transfer, and the trust would pay you an income stream for the rest of your life. When you die, the asset in the charitable trust would go to the designated charity.
For example, assume you have a vacant piece of property that is worth $1 Million, and if you sell it, you would pay $250,000 in taxes, leaving you with only $750,000. If you transfer the property to a charitable trust, the trust could sell the property without paying income taxes, thereby leaving the trust $1 Million in assets to use for paying you an income stream. You would therefore receive income based on the $1 Million, not the $750,000 you would have remaining if you sold the property and paid income taxes.
One down side with this transaction is that you are giving up the right to the principal in the charitable trust, i.e., the proceeds from the sale of the asset. You are limited to the income from the charitable trust.
Assets you leave to charities at your death are not subject to estate taxes. Therefore, if you are charitably inclined, you could include charitable gifts at your death.
In addition, you could set up a charitable trust at your death and have assets transferred to the charitable trust. The trust could be set up to pay the income to a specified charity for a specified number of years, after which the assets will come back to your family members. This will allow your estate to receive an estate tax deduction for the charity’s receipt of money from the charitable trust. While this will not have the same estate tax effect as leaving the asset outright to the charity, it will help reduce estate taxes, and return the assets to your family after the specified time period.