Can Paying Gift Tax be a Good Thing?

Passing wealth from one generation to the next represents an opportunity for the government to assess tax. If you pass away in 2021, and your estate exceeds $11.7M, tax applies. The current administration has proposed reducing that exemption to as low as $3M. Either way, if you think that your assets are going to be taxed when you pass away, it seems like you could just give them away first.

The extent that you give your assets away reduces the exemption. If you wanted to give all $11.7M of assets now, then your exemption is reduced to zero. If you give away more than the $11.7M, you have to pay a gift tax. You would want to wait as long as possible to pay tax, right? However, paying gift tax right now can be a good thing.

Assume your estate is worth $31.7M, and you give away everything today. The estate and gift maximum tax rate is 40%. After the exemption, taxable gift is $20M. At 40%, tax is then $8M. If you pass away today, the same calculation applies, so the tax is also the same, at $8M. Here is the difference:

Source: Charles Williams

In this example, the beneficiaries got $1.6M more when the assets were gifted, rather than inherited.

With this in mind, it seems like you could just wait until later. At the last minute, you could gift everything, pay the tax, and still take advantage of the above strategy. Enter IRC Section 2035(b) which denies this “deduction” for any gift tax paid within 3 years of death. This means that, if you want to take advantage of this strategy, the gift needs to be made more than 3 years before you pass away.

As you can see, under certain circumstances, paying gift tax can be a good thing!

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