The Retirement Corporation of America

The Tax Advantages of Giving Your Wealth Away

IF YOU DON'T own it, it isn't part of your estate. If you don't own an asset, then you can't be asked to pay tax on the income from that investment. You can get a warm feeling from giving wealth away to other people and there are also many tax advantages.

Giving It Away Within the Family

The most tax-effective way to give money away is to use the annual gift tax exclusion. You can make gifts close to $11,000 each to as many recipients as you want, free of federal gift tax. That can be doubled—to $22,000 per recipient—when the gifts are made jointly by a married couple. Giving money away is especially useful if you and your spouse want to shift assets out of your estate to minimize estate taxes when you die. But even if estate taxes aren't a concern, the exclusion does provide an easy, tax-free way to give money to your kids.

You can give away money by paying for a child's education or medical expenses. These expenses can be paid by you making a gift, without taxation, no matter how large the amounts. The only rule is that the payment must be made directly to the education or medical service provider—such as a college or hospital—not to your son or daughter.

If the kids are minors, gifts can be made by opening a Uniform Gifts to Minors Act (UGMA) account or, in some states, a Uniform Transfer to Minors Act (UTMA) account. A UGMA/UTMA account is a trust like any other trust except that the terms of the trust are established by federal law instead of being drawn up in a trust document.

To establish a UGMA/UTMA account, go to a stockbroker, bank, mutual fund manager or savings & loan. You'll have to use the minor's social security number as the taxpayer ID for this account. If the investments generate income, that income is taxed as follows:

•  If the child has no other income and is under age 14, the first $700 of investment income falls into the child's zero tax bracket. The next $700 is taxed at 15% and the rest is taxed at the parents' top bracket. This is the so-called "kiddie tax."

•  If the child is 14 or over, all the income is on the child's return and he or she owes the taxes.

The best bet for giving, if there are kids to educate, is a Section 529 plan (named for the appropriate section of the IRS code). You can make cumulative tax-free contributions of up to $250,000 to a 529 plan for a child or grandchild. There's no upfront tax deduction for contributions to a 529 plan, but all withdrawals from 529 plans are now tax-free as well, provided you use the money to pay college bills.

Each state has its own 529 plan. Specifics—including contribution limits and investment options—vary from state to state. What's common to all plans is that this is a very compelling deal, which moves money out of your estate.

Parental contributions to pay school bills don't incur a gift tax. Now 529 plans offer a break to grandparents or other relatives who want to help pay for school. Normally, the limit on tax-free gifts to one recipient is about $11,000 a year—$22,000 for a couple. But 529 plans allow you to contribute up to $55,000 per child—$110,000 from a couple—in a single year without triggering a gift tax.

Giving It Away to Others

There is no end to the clever ways you can save both income and estate taxes by giving wealth away to schools, charities and other worthwhile endeavors. There is hardly any limit to what you can give—as long as it has value to the recipient. To cite just a few examples, you could give away:

•  Stocks or bonds that have appreciated in value.

•  Works of art.

•  Property that you own.

•  Clothing you no longer want that is still wearable.

•  Household possessions you no longer use that might be useful to others.

The list is virtually endless. You simply need to:

1. Have something of value to give away. There is virtually no limit to what that might be. It just has to be worth something to someone.

2. Someone who wants to receive that item. The recipient must be recognized by the IRS as a legitimate charity or educational or religious institution. You can't give last year's wardrobe to Aunt Ruth and claim a tax deduction. You could claim the deduction if you give the wardrobe to the Salvation Army or your church for its rummage sale.

3. A method for determining the value of what you have given away. That's easy if it a stock or bond. The value is the market value on the day you gave it away. If it is an item of some value—art or an antique or jewelry—you will have to produce something from a recognized expert in the field stating that the item is worth what you say it is. For items of lesser value—old clothing, furniture, appliances, etc.—you have a lot of latitude in estimating value. The rule here is "fair market value"—what a reasonable person would pay you for the item on the day you donated it.

You do have to fill out Form 8283—Noncash Charitable Contributions—and attach it to that year's tax return. Also, you must receive a written acknowledgement from any charity to which you gave assets worth $250 or more.

What You Gain From Giving

At the least, you get to take a deduction on your income tax for your charitable contributions. That will reduce your tax bill in the year you made the contribution. The advantages are compounded when you make gifts of appreciated assets—stocks or bonds or property that have gained in value.

Let's say you own 1,000 shares of the Jubilee Lollipop Company that you bought for $5,000 and that now are worth $50,000.

•  If you keep the shares, they probably will keep appreciating in value—adding to the likelihood that you will leave a taxable estate when you die.

•  If you sell the shares, you will face a capital gains tax on your $45,000 gain.

The solution is to donate those shares to a legitimate charity. By doing so, you gain three ways:

1. You get to take a charitable deduction at the fair market value of those shares—$50,000.
2. You won't owe a penny of capital gains tax on that $45,000 gain.
3. The value of those shares is removed from your estate—reducing your potential exposure to estate taxes.

That's the short course in giving assets away. There are various sophisticated techniques involving such devices as Charitable Remainder Trusts, where you give assets away but continue to benefit after those assets are out of your hands.

Mostly such devices are for the very wealthy. Still, you never know. If you have studied all these lessons and taken them to heart, you might very well become wealthy enough to make use of all the tax and estate planning techniques that professionals can come up with.

After all, once you first decide to seek financial success, there is simply no telling what good things will come your way.