I. TRANSFERS DURING LIFE AND EXCLUSIONS FROM GIFT TAX.

Under the federal tax laws, whenever a taxable gift is made, the donor (i.e., the person making the gift) is responsible for the payment of gift tax. However, there are two exclusions from the imposition of the gift tax that are widely utilized: the annual gift tax exclusion and the exclusion for gifts for educational and medical expenses.

The annual gift tax exclusion allows each individual to make gifts of up to $15,000 per donee per year without using any part of his or her applicable exclusion amount or paying gift tax. Married couples can make gifts of up to an aggregate of $30,000 per donee gift tax free, regardless of which spouse makes the gift. This is known as “gift- splitting” and is treated as if each spouse made one-half of the total gift.

The exclusion for gifts for educational and medical expenses, allows an individual to pay for anyone’s tuition and medical care expenses, free of gift and generation- skipping transfer (“GST”) taxes, provided that such transfers are made directly to the educational institution or medical care provider. This exclusion is available in addition to the annual gift tax exclusion and applies without regard to the relationship between the donor and the individual on whose behalf the payments are made.

II. ESTATE TAX REDUCTION STRATEGIES.

There are several current gifting strategies that a client may wish to use to reduce his or her potential estate tax liability. First, clients should consider making full use of the annual gift tax exclusion.

A. Annual Exclusion Gifts.

As noted above, the annual gift tax exclusion enables individuals to give up to $15,000 per year per donee in 2018, without incurring a federal gift tax. Maximizing the use of a client’s annual gift tax exclusion will shift future appreciation on the gifted assets away from the donor’s estate. Over time, these annual exclusion gifts will result in a significant wealth transfer. Thus, if a client has not already made the maximum transfers to or for the benefit of his or her children or other beneficiaries, he or she should consider doing so at this time.

1. Gifts in Trust.

   In order for a gift to be eligible for the annual gift tax exclusion, it must be a gift of a “present interest.” Generally, a gift in trust is not a gift of a present interest. However, there are three exceptions to this general rule:

   • Custodial accounts established for a minor, under the either Uniform Gift to Minors Accounts (“UGMA”) or Uniform Transfer to Minors Accounts (“UTMA”);
   • Trusts for minors which meet the requirements of Section 2503(c) of the Internal Revenue Code of 1986, as amended (the “Code”); and
   • Transfers to trusts that give the beneficiaries an immediate right to withdraw the transferred amounts (“Crummey Trusts”).

   Each of these exceptions is explained in greater detail below.

   (a) Uniform Gift or Transfer to Minors Accounts.

   Gifts to a minor under an UGMA or UTMA can be completed with relative ease and simplicity. All that is required is the creation of a custodial account at a local bank or brokerage firm. However, the terms of an UGMA or UTMA account require that the custodian relinquish control of the custodial property to the beneficiary when he or she attains the “age of majority.” Most states define the age of majority as either age 18 or 21. Thus, at the age of majority, the beneficiary becomes entitled to any property held in his or her custodial account. For estate tax reasons, it is generally not advisable for the minor’s parent to be the custodian of an UTMA or UGMA account. While the child is a minor, if the parent serves as the custodian and passes away, the value of the custodial assets will be includible in the parent’s estate for federal estate tax purposes.

   (b) Section 2503(c) Trusts.

   If a trust meets the requirements of Section 2503(c), gifts to the trust in the amount of the annual gift tax exclusion will not be treated as taxable gifts. The terms of a Section 2503(c) trust must provide that: (1) the income and principal of the trust may be used for the benefit of the beneficiary until he or she attains the age of 21; (2) upon attaining age 21, the beneficiary has the right to receive the principal and undistributed income from the trust; and (3) if the beneficiary dies prior to the termination of his or her trust, the trust property must be includible in the beneficiary’s estate for federal estate tax purposes.

   Generally, Section 2503(c) trusts are drafted to meet the second requirement by giving the beneficiary the right to withdraw the trust property for a brief period following his or her 21st birthday. If the beneficiary does not withdraw the trust property during that period, the right to withdraw such property terminates and the funds will remain in trust for his or her benefit according to the desired terms as stated in the trust agreement (e.g., distributions at specific ages or retention of property in lifetime trust).

   The third requirement is generally met by giving the beneficiary a testamentary general power of appointment over the trust assets. A general power of appointment entitles the beneficiary to direct who will receive the trust assets at his death to a class of potential distributes which must include the beneficiary’s estate, the beneficiary’s creditors, UorU the creditors of the beneficiary’s estate, by including a provision exercising the power of appointment in his or her Will.

   (c) Crummey Trusts.

   As noted above, another method of ensuring that transfers to a trust will qualify for the annual gift tax exclusion is to give the beneficiaries of the trust an immediate right to withdraw the property transferred. These withdrawal powers are known as Crummey withdrawal powers. The case of Crummey v. Commissioner of Internal Revenue and a long line of subsequent cases and rulings have established that a gift to a trust will be recognized as a gift of a present interest if the beneficiary has an immediate right to withdraw the transferred property. To qualify for this exclusion and avoid having a gift to a trust constitute a taxable gift, a trust agreement can provide that each time a transfer is made to the trust, the beneficiaries have the right to withdraw a portion of the gift for a limited period of time (for example, 30 days). If the beneficiary does not exercise the right within that time period, the right terminates and the amount transferred is held in trust for the beneficiary’s benefit.

2. Unlimited Gifts for Education and Medical Expenses.

   Another effective gift-giving strategy is the use of the unlimited exclusion from gift tax for payments made directly to an educational institution for “qualified tuition related expenses” or payments made directly to a medical provider for the donee’s “qualified medical expenses.”

   These tuition payments may be made for the benefit of a child or grandchild to any educational institution, including, but not limited to, private schools from K-12. Moreover, these unlimited qualified payments may be made in addition to annual gift tax exclusion gifts (currently $15,000) to the child or grandchild.

3. Section 529 Plan Accounts.

   A Section 529 Plan Account is a qualified state tuition program that allows contributions to grow income tax free (analogous to a Section 401(k) plan or IRA account). Virginia, Maryland, and the District of Columbia offer very competitive 529 Plan Accounts that have greater investment choices and administrative flexibility than most other state programs and, like most states, they do not restrict the beneficiary’s choice of eligible educational institutions to only those within the plan sponsor’s state.

   Currently, distributions from a Section 529 Plan for “qualified education” expenses will be 100% income tax free. This means that once assets are placed in a Section 529 Plan Account, if the assets are used for educational purposes, there will be no further income or estate tax on the assets in the account (and all of the appreciation in these assets). If for some reason the funds distributed are not used for educational purposes, the beneficiary must pay income tax on the earnings and must also pay a 10% penalty.

   Also, the donor will retain ownership of the Section 529 Plan’s assets until they are used for educational purposes, which allows the donor to retain more control than other gifting options. The donor should consider funding a separate Section 529 Plan account for his or her children (and future grandchildren) as part of the donor’s annual gifting strategy.

   B. Gifts of All or Part of the Client’s Applicable Exclusion Amount.

   To the extent a client wishes to implement additional planning strategies after making annual gift tax exclusion gifts and qualified transfers for tuition and medical care expenses in order to further reduce his estate tax liability, we suggest gifting all or a portion of the client’s federal gift tax exemption amount.

   Every individual has an applicable exclusion amount which currently exempts $11,180,000 from the imposition of federal gift and estate tax. The applicable exclusion amount can be used during life. The primary benefit of gifting the applicable exclusion amount during life is also removing the future appreciation realized by the gifted assets from the donor’s estate. To the extent that the applicable exclusion amount is not used during life, it will be available at the time of death to offset any federal estate tax.

   In addition to making outright gifts of appreciating assets, there are several techniques designed to “leverage” the donor’s gifts. These techniques are beyond the scope of this memorandum.