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Wednesday, March 31, 2010

Mercer County

As most of you may know, I am an attorney with clients based primarily in Mercer County, New Jersey. Accordingly, I was curious how much in estate taxes the residents of each county pay. While having trouble finding that information, I did stumble across some data on the www.taxfoundation.org web site which breaks down how much the residents of each state paid in state estate taxes in 2007.

Not surprisingly, New Jersey residents paid the most per resident, with Pennsylvania residents paying the 2nd most and New York residents paying the 3rd most. What does this mean in real numbers? New York, which received the most in terms of total dollars collected, only received $1,053,384. Pennsylvania collected only $736,610 and New Jersey only collected $586,589. In the scheme of things, this is represents less than .02% of each state's budget.

To be honest, I was a bit surprised by how little was collected, both on a percentage basis and in terms of total dollars. If anyone could send me additional information on other estate tax facts, such as breakdown by county, I would appreciate it.

Wednesday, March 24, 2010

The Importance of Planned Gifting

One of the best ways to minimize your taxable estate is through planned gifting. Anyone who may be subject to a federal or state estate tax, or a state inheritance tax, should at least consider a gifting plan.

The first item to think about is - can you afford it? This is not always an easy question because you may be worth a lot of money, but you might not have a large income to cover your annual expenditures. Accordingly, sometimes the best items to gift are items that do not produce a lot of income, but are worth a lot of money for estate tax purposes. Vacation homes, valuable art collections and a minority interest in a business are all perfect examples of this.

Once you figure out whether you can afford to make a gift, the second question is how much to gift and who do you wish to benefit. These go hand in hand because often times you only wish to benefit certain people or certain charities by a set dollar amount rather than by everything you can afford to give away.

When trying to calculate how much to gift, valuation of the gift becomes crucial. It is beyond the scope of what I wish to discuss here, but be aware that certain gifts may valued at less than you think because discounts should be taken if the gift is not freely marketable and/or the donee does not have much control over the asset after it is received.

Additionally, tax law often plays a key role in how much you give away. Even if you can afford to give away $2,000,000 to charity or to your grandchildren, it may be more beneficial for tax reasons to make smaller gifts over a number of years rather than a large lump sum gift.

This leads us to the third item that we must think about in a gift plan is the timing of the gift. (For more information on this, see my earlier blog post on timing.) You may be aware that the federal government allows you to gift away a certain amount every year (currently $13,000) without a gift tax consequence. Moreover, you may gift away up to $1,000,000 before there is any out of pocket gift tax consequence because you are entitled to a $1,000,000 federal gift tax exemption.

Any good gifting plan is going to try and make maximum use of your lifetime gift tax exemption, annual exclusion amounts as well your ability to pay for
another person's educational or medical expenses without incurring any tax consequences. (There is technically no gift if you make payments, for the benefit of another person, when such payments are made directly to certain educational institutions or medical care givers.)

Due to the annual exclusion allowance, practitioners frequently encourage clients to make gifts to their loved ones over the course of many years

The final item to think about, is the manner in which the gift is made. There are thousands of different ways to make gifts. You can make gift directly to the person or charity you wish to benefit. You can make a gift via a trust (and there are many different trusts such as insurance trusts, charitable lead or remainder trusts, dynasty trusts with or without withdrawal rights, qualified personal residence trusts, etc.). You can make gifts to a 529. You can give away partial ownership of a property. You can have an indirect gift by "giving" money to a company in which you are not the sole owner and not getting anything in return for that extra contribution. You can give up a power that you were entitled to.

Once you have figured out what you can afford, who you want to benefit, how much you want to give, when to make the gift and how to make the gift - then you have a truly planned gift.

NOTE: All items discussed here assume that you are a US citizen or permanent resident alien.

Timing of a Gift

When doing gift planning, it is imperative to have the gifts completed on the schedule that you want otherwise you may accidentally gift too much one year, causing a tax, or you may gift too little, and lose your annual gift tax exclusion for the year.

Therefore, you must know the answer to this question: When is a gift complete for purposes of the federal gift tax?

Unfortunately, tax law is much like a magic trick - what may appear to be true is not always true. If you give someone cash, is the gift is complete the moment the other person receives the cash? What about a check? What about a transfer of real estate by deed?

Would it make a difference if, when giving you the cash, I told you that you could only spend it on a new car, otherwise I want it back? What if there was not enough cash in the account to cover the check? What if after making the deed I held it and did not show it to anyone else or record it? Things get trickier then

Three elements are required to establish a gift: "(1) donative intent on the part of the Donor; (2) an actual or symbolic delivery of the subject matter of the gift; and (3) an absolute and irrevocable surrender by the donor of ownership and dominion over the subject matter of the gift, at least to the extent practicable or possible, considering the nature of the thing to be given." (Jennings v. Cutler, 288 N.J. Super 553 (App. Div. 1996)

Donative intent means that the person making the gift (or the Donor) believes in his own mind that he is giving something away. For example, if I give you cash, but I expect you to repay it, it is not a gift - even if I do not tell you at the time that I want to be repaid. Since I expect to be repaid, I do not have the proper mindset, or intent, to qualify this as a gift.

The moment that I no longer wish to be repaid, then that transfer can be a completed gift if the other requirements are met. Often times practitioners make positive use of this intent requirement. We can draft a promissory note for a parent transferring a large sum of money to a child, whereby the child agrees to pay back $X per year. The parent can then forgive that annual repayment, thereby completing a gift as to $X. This technique is commonly used by a parent who wishes to help a child make a down payment on a house, but does not want to use up their lifetime $1,000,000 gift tax exemption. The payments of $X can be structured to be less than or equal to the annual exclusion amount, thereby passing on additional money free of gift and/or estate taxes.

To have actual or symbolic delivery is important because it puts the person receiving the gift (the donee) on notice that they are receiving something. Let's go back to the example of a person making a deed for the benefit of their child and then keeping hidden away from the world. It would be similar to make saying to myself that I'm going to give each of my blog readers $100,000, putting the money in my sock drawer, but not telling you about it. I may have the proper intent, but unless there is some further act, it is not enough.

What further act is necessary puts us into a gray, mushy area of the law. I do not physically have to give you the gift. Some sort of act in furtherance of the gift is enough. Three situations that come up frequently are the writing of a check, the preparation of a deed and the transfer of a business ownership interest, so I will discuss them a bit further.

If you write a check to another person, the gift becomes complete when you've gone that extra step to ensure the other person receives the check. This could mean physically handing it to them or putting it in the mailbox. If there is not enough money to cover the check in your account, the gift would not be complete until there is enough money in the account to cover it. (This gets into another gray area however if bank covers your check.) If, however, you tell the donee not to cash it yet, and they obey, then the gift is not complete until they receive permission to cash the check.

For the gift of real estate, the donor does not necessarily have to record the deed, but the recording of a deed clearly proves the gift was made. (see Fischer v. Gerndt, N.J. Eq. 53, 55 (Ch.1922). Anything short of the deed being recorded puts us in yet another mushy gray area of the law. You could give the deed to the donee to record, which would complete the gift, but then take out a mortgage, negating the gift. You could give the deed to the donee's agent, which would complete the gift, but then sell it that same afternoon to another party, negating the gift. Ultimately, it would be an after the fact determination. Accordingly, when doing gift planning, you should not wait until the end of the year to transfer real estate, because it can take up to a month to record the deed. As stated in the beginning, timing is everything for proper gift planning.

For a gift of a business interest, the donor does not necessarily have to enter something in the stock book or file something with the state, but doing so clearly completes the gift. A letter by the donor to the donee stating, "I hereby give you 10% of XYZ business" could be enough, unless the donor turns around quickly and sells it to someone else. As with the deed, for proper planning, it is best just to take the appropriate steps to make the gift clearly complete.

With respect to the final requirement, "
an absolute and irrevocable surrender by the donor of ownership and dominion over the subject matter of the gift, at least to the extent practicable or possible, considering the nature of the thing to be given", it is actually a mouthful but easy to show by example. If I tell you that you can have my art collection when I am done with it - it is not a gift until I tell you I'm done with it. In the example at the beginning, the gift of cash subject to the fact that you can only use it for a new car, the gift is not complete until you either use it for the new car, or I change my mind and agree you can have it no matter what. Generally, you have to give up control of what you are gifting. When you have done that, this element is satisfied.

For more on the importance of planned gifting, see: The Importance of Planned Gifting

Note: Thanks to Paul Kostro for keeping me up to date on much of this information. Paul's Blog can be found at: http://www.kostrolaw.com/NJFamilyIssues/