Gifting Away Assets During Your Lifetime

By BLAKE A. PRATZ and CHRISTOPHER L. MYERS

If you want to engage in lifetime gifting you should be aware of certain rules. The annual gift tax exclusion amount is $11,0001 per year per person in 2004 and the lifetime gift tax exclusion amount is $1 million through 2009.
The top gift rate will be incrementally reduced from 48 percent in 2004 to 45 percent by 2007. In 2010, the top gift tax rate will equal the top individual income tax rate (estimated to be 35 percent). Any portion of the lifetime gift tax exclusion used will reduce your estate tax exclusion by that amount. You should consider some creative options that may allow you to increase the size of your gifts while minimizing any gift tax. Here are a few strategies to leverage lifetime gifts:

The Grantor Retained Annuity Trust (GRAT)
A GRAT allows you to pass along assets you believe will appreciate in value to family members at discounted levels. You contribute assets to the trust and receive a fixed annuity payment stream for a specified period of years. At the end of the trust term, the remaining assets and their appreciation are distributed to your beneficiaries. Since the initial value of the gift is reduced by the present value of the annuity payments, you could structure a payment schedule and amount that could result in a minimal gift tax value. However, if you die before the end of the specified term, the trust property would be included in your estate and subject to estate taxes.

Life Insurance
You could use life insurance to help reduce your estate and gift tax liabilities. Life insurance often provides a substantial benefit for relatively small premium dollars. It may be used by itself to increase the size of your estate, creating an “instant” estate. Or, it may be used for liquidity and paying estate taxes cost-effectively. And, the proceeds of life insurance are typically income tax-free to the beneficiary. With careful planning, these proceeds may also be received estate tax-free.

The Limited Liability Company (LLC) or Family Limited Partnership (FLP)
An LLC or FLP might be a useful leveraging technique. An LLC or FLP may provide a tool for reducing the size of your estate for transfer-tax purposes and let you retain control and management of your assets.2 The LLC or FLP is made up of managing or voting interests and nonvoting interests. You could retain the voting and managing interests (thereby keeping control and management of the assets) and gift the non-voting interests to your children and grandchildren. Since gifts to your children and grandchildren lack voting rights and are not readily marketable, they might be discounted for gift tax valuation purposes.3

The Dynasty Trust
The Dynasty Trust could allow you to maximize the use of your lifetime gift tax exclusion. Here’s how it works: Generally, you would fund the trust with an amount up to yours and your spouse’s lifetime gift tax exclusion. The trust assets, including any growth, will remain free from federal transfer taxes (i.e., estate, gift and generation skipping transfer taxes) for as long as they remain in the trust. In certain states, such as South Dakota, the trust may theoretically last forever.
Income or principal from the trust may be distributed to your children, grandchildren and great grandchildren as specified in the trust document. The provisions could tie those distributions to incentives, such as maintaining gainful employment, and permit distributions for funding businesses or purchasing homes for the use of beneficiaries or other activities. There may also be provisions in the trust document to gift a percentage of the assets directly to a charity or family foundation. Assets remaining in the trust are protected from creditors and divorce judgments.

Create Your Estate Plan
Discuss your estate planning objectives and concerns with your financial consultant and your tax and legal advisors. Together you can develop an estate plan that addresses your unique financial and family situations so that you can effectively transfer wealth to your beneficiaries.

Endnotes
1. This amount may be adjusted annually for inflation. 2. You should consult with your legal or tax advisor about the appropriate FLP or LLC ownership structure and the corresponding tax consequences. 3. You should consult with a qualified appraiser to determine the appropriate amount of the valuation discounts.

Blake A. Pratz is a Senior Vice President-Investments/Senior Investment Management Consultant and Christopher L. Myers is a Second Vice President-Investments/Investment Management Specialist/Financial Consultant of The Pratz/Myers Group at Smith Barney, located in the Houston Downtown office. Their experience is in financial management for the legal profession. Smith Barney does not provide tax or legal advice. Please consult your own personal advisors for such information. Smith Barney is a division and service mark of Citigroup Global Markets Inc. Member SIPC.

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