Cost/Benefit of Lifetime Gifts

Gifts made during lifetime can help minimize (or eliminate) federal estate tax otherwise payable at death in a number of different ways. Gifts that use the annual gift tax exclusion are an obvious example, because the gifts are not subject to gift tax and not subject to estate tax. Gifts that use the applicable exclusion amount (currently $11,700,000 in 2021) are a less obvious example, because there is no gift tax to pay, but using the exclusion during lifetime means that there is less exclusion to apply for estate tax purposes at death. However, gifts that use the exclusion can nevertheless help to avoid estate tax if the gift is of appreciating property (such as common stock or real property) because the post-gift appreciation will not be subject to estate tax.

The disadvantage of lifetime gifts of property is that the donee (recipient of the gift) receives the property with the donor's income tax basis, while if the property had been held until death the property would have received a new income tax basis equal to fair market value at death (or at the alternate valuation date six months after death, if that would reduce the estate tax otherwise payable). So a lifetime gift of appreciating property has a possible estate tax benefit because post-gift apprecation is not subject to federal estate tax, but has a possible income tax cost because all pre-death appreciation (including pre-gift appreciation) may be subject to tax as capital gains.

One way to compare the income tax costs with the estate tax benefit is to project the future value of the property using an assumed rate of growth in value, then calculate both the possible estate tax on that post-gift growth and the possible income tax on the pre-gift and post-gift appreciation. The difference between the possible estate tax on the post-gift appreciation and the possible income tax on all of the pre-death appreciation is the net benefit of the lifetime gift.

Two additional calculations are possible:

The net benefit of the lifetime gift increases if the donor's basis in the property is nearer current market value, the assumed rate of growth is larger, or the donor is younger. The net benefit decreases if the property has a lower basis, the growth rate is lower, or the donor is older.

These calculations do not take into account the possibility that the property might not be sold for many years post-death, and so the tax on the capital gains might be deferred for many years (or avoided entirely if the beneficiary or beneficiaries who inherit the property should die before selling the property, so that the property receives a new income tax basis and the tax on the appreciation disappears). There is also the possibility of future tax law changes that would change the projected estate tax or income tax liabilities.