The Art of Gifting UP

Kristin Sun

In today’s world of innovation, where one idea could turn a young entrepreneur into an overnight million(billion)aire, it is becoming increasingly common for a financially successful individual to accumulate far more wealth than their living parents ever could. It is in this group of high net worth investors where a unique wealth transfer strategy may make sense. 

Gifting and wealth transfers between generations are generally considered a one-way street: parent to child; grandparent to grandchild; older generation to younger generation. Gifting down the generation stream allows one to reduce their taxable estate while also passing an inheritance onto loved ones. This is especially important if your anticipated estate is larger than the 2017 lifetime estate tax exemption of $5.49 million per person, or $10.98 million for couples. 

But let’s take a step back and imagine breaking with tradition by reversing the traffic flow upstream and instead gifting UP to mom, dad, grandma, grandpa or some other elder. If implemented in the right situation, you can potentially set yourself up to inherit those same assets (and plus some significant tax savings) down the road.

A Simple Case Study

John is a successful entrepreneur and has a large portfolio of low basis stock. John has no siblings and his mother has a gross estate well below the $5.49 million level. In this situation, John could gift shares to his mother, knowing that upon her passing, he would re-inherit the shares after they received cost basis reset to the current market value. At that point, he would be free to sell with far less tax impact than selling the original shares he owned. 

There are many points to consider in this scenario:

•    To avoid dipping into John’s own lifetime exemption, he would be better served to gift his mother $14,000 (or $28,000 if married) worth of stock every year. By staying at or below the annual exclusion limit, he preserves his lifetime exemption of $5.49 million ($10.98 million if married). 

•    John and his mother must be willing to bear the market and opportunity risk of owning the stock long term. In today’s high equity compensation driven world, John likely would have been forced to bear that market risk anyway, especially if he was held to trading restrictions by the company directly, or simply wanted to avoid paying the high taxes associated with selling low basis stock.  

•    In this example, John is his mother’s only heir, so little to no estate planning work would be required if her plan already includes the transfer of all her assets to John. If there were other siblings, family members, or even charitable beneficiaries involved, John would first need to ensure the gifted property is specifically bequeathed to him in her estate plan. 

•    John could choose to utilize this strategy to help fund his mother’s living expenses, with any unused assets transferring back to him upon her death. Likely, there would still be tax savings if she were in a lower tax bracket and thus could sell the shares with less of a tax burden. 

There are many situations where “gifting up” may not be appropriate, including a complex family dynamic where gifted property may not be returned. Also, if the taxable estate of all parties involved already exceeds the lifetime exemption limits, there would be no tax savings to capture. Once property is gifted away, it is important to understand that ownership, and therefore control, also transfers. There must be a healthy, trust-filled relationship between the giftor and recipient to ensure the assets are left intact - if that is the ultimate intent. 

A Look Back at History

If John chose to gift beyond the $14,000 per person per year annual exclusion, he would be subject to gift tax returns and he would erode his own $5.49 million lifetime exemption. To address this possibility, let’s take a deeper look at the history of the lifetime exemption amount:

In 1997, the lifetime exemption was only $600,000 and the top estate tax rate was a flat 55%. This remained in place for 5 years (adjusted for inflation) until it was bumped up to $1 million from 2002-2010. It received another bump in 2011 to $5 million and has been adjusted for inflation each year until now, where it stands for 2017 at $5.49 million and a top federal estate tax rate of 40% flat for 2017. These figures are “permanent” until, of course, Congress decides to change the rules. 

If there are (hopefully) many years between now and John’s ultimate death, he could be waiting a long time to finally use up his lifetime exemption. By gifting these assets now, he may reduce his lifetime exemption, but still accomplish removing the assets from his estate, giving them the opportunity to obtain the step up in basis at his mother’s passing. And, if the lifetime exemption amount were to be reduced at some point in the future, he’ll be content knowing he had already taken advantage of the tax-free transfer before those changes went into effect. 

Just like constructing a work of art, finding the right way to utilize this wealth transfer strategy takes careful consideration and thoughtful execution. If the suitable circumstances exist, this strategy can be immensely beneficial. That said, with the current leadership in Washington, D.C., we simply do not know how income tax rules and especially estate tax rules may or may not be changing in the next few years. Regardless, this commentary was written based on the current policies in place. In addition, since implementing any form of wealth transfer strategy can have significant tax implications, always consult with your Sand Hill Wealth Manager and tax professional prior to taking any action. 

Annual Exclusion and Lifetime Exemption figures sourced from the Internal Revenue Service

This information has been developed internally and/or obtained from sources that Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor. This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security. This information reflects subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. This material reflects the opinion of SHGA on the date made and is subject to change at any time without notice. SHGA has no obligation to update this material. We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA. In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances. Transactions in securities give rise to substantial risk and are not suitable for all investors. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.