Ok, get ready for a topic that is not exactly a favorite of mine. Number 1 – I am still learning a lot about it. Number 2 – Like most, I’m not always super excited to talk about my mortality. But this is really important. Understanding and planning for your gifting and estate tax obligations can be tricky in times of economic uncertainty. But a solid gifting and estate tax plan is essential to achieving long-term financial security for you and your loved ones—no matter the economic climate. So, we are going to talk about gifting and estate planning during a recession…
But, like I said, I am not an expert here…And I said I would always be honest. So, in full transparency, this is an area that Selenid and I need to pay way more attention on…
So, I asked my tax advisor, Alexis E. Gallati, EA, MBA, MS Tax, CTS, the founder and Lead Tax Strategist at Cerebral Tax Advisors, and the author of the book “Advanced Tax Planning for Medical Professionals” to help me out!
You may remember her as the creator of my personal tax plan shared here. She also grew up in a family of physicians and is married to a private practice physician who coincidentally did his residency at University of Rochester when I was a medical student there (small world!).
But anyway, in this post, we’ll cover why gifting and estate planning is crucial during a recession and how you can make the most of an economic downturn.
While the primary goal of your estate plan may be to provide for loved ones or leave a legacy to causes near your heart, minimizing taxes is a critical component.
For 2023, the lifetime gift and estate tax exemption stands at an all-time high of $12.92 million per individual. This is up from $12.06 million in 2022. Those numbers are doubled for married couples. Any value over that lifetime exemption is taxed at rates ranging from 18% to 40%.
With such a high lifetime exemption, very few estates are taxable—at least on a federal level. However, eleven states (Washington, Oregon, Hawaii, Minnesota, Maryland, Illinois, Vermont, New York [Yay, New York!], Maine, Massachusetts, Rhode Island, Connecticut) and the District of Columbia have an estate tax. Five states (Nebraska, Iowa, Kentucky, Pennsylvania, Maryland, and New Jersey) have an inheritance tax. Exemption amounts vary by state and are often much lower than the federal amount.
In addition, the current federal exemption level is due to sunset at the end of 2025. If Congress doesn’t extend the current increased exemptions, as of January 1, 2026, the exemption will revert to $5 million per person, indexed for inflation.
This means taxpayers have a potentially time-limited opportunity to transfer wealth and shelter assets from estate taxes.
Gifting as part of your estate plan
Gifting is a crucial part of tax planning for doctors, providing an opportunity to reduce your overall taxable estate while ensuring you take care of loved ones.
The annual gift tax exemption allows individuals to make tax-free gifts up to a certain amount each year without triggering a gift tax return filing obligation or owing any gift taxes. For 2023, the federal gift tax exemption is $17,000 per recipient per year. This means you can give any individual up to $17,000 in a single calendar year without paying federal gift taxes. Married couples can double that amount to $34,000 per recipient per year.
Cash is one of the most common ways to take advantage of the annual gift tax exemption. But you can also gift stocks and bonds, real estate, life insurance policies, personal property, and business interests.
The benefits of gifting and estate planning during a recession
During a recession, the value of your estate may take a hit. Real estate prices may fall or flatten. Stocks and other investments are down. And even the value of your practice might decline.
This presents a unique estate planning opportunity. Gifting assets in a down market allows you to transfer more of your estate tax-free and potentially provide for business succession planning.
For example, say your practice was worth $1 million five years ago, but during a recession, its value is $750,000. Your two adult children work for you in the practice. And you want them to take over the business someday.
Five years ago, when the practice was valued at $1 million, and the annual gift tax exclusion was $15,000, you could gift each child a 1.5% interest in the business (worth $15,000) without triggering any gift tax obligations. Today, with the practice value lower and the annual gift exemption higher, you could gift each of them a 2.2% interest in the business and be under the annual limit.
While that may not seem like much, do that several years in a row. Now you’ve managed to transfer a significant portion of the practice out of your estate with no tax consequences. In addition, your heirs will benefit from the appreciation of value once the economy normalizes.
Another advantage of gifting during a recession is that it can provide an immediate financial boost for your loved ones
Especially those impacted by job loss or income reduction. For example, imagine if your child or another family member lost their job and is having trouble paying their mortgage. You could gift them up to $17,000 ($34,000 if married and splitting gifts with your spouse). This can help them cover their bills until they can get back on their feet.
Also, keep in mind you can stretch the gift tax limit by paying a family member’s education tuition or medical expenses directly to the educational institution, health care provider, or health insurance company. This type of giving does not count toward your annual gift tax exemption limit.
Understanding capital gains taxes in estate planning
When used strategically, gifting during a recession can reduce the overall taxable estate while providing immediate and long-term financial security for your loved ones. However, it’s essential to understand your gifts’ potential capital gains tax implications.
By gifting appreciated assets, you can avoid capital gains taxes on those assets. But giving stocks, bonds, real estate, and other investments can have capital gains tax implications for your beneficiaries when they sell the asset.
When you gift an asset during your lifetime, the recipient receives your basis in the property. For example, say you give $10,000 of Apple stock to your grandchild. You paid $5,000 for the shares. Ten years later, your grandchild sells the stock for $20,000 to help pay for college. They would have a $15,000 capital gain—the $20,000 sales price, less the carryover basis of $5,000.
On the other hand, if the gift was made after your death (i.e., included in your estate), the recipient’s basis would be the fair market value at the time of death. For example, when you pass away, the Apple stock is worth $20,000. If your grandchild immediately sells the stock for its fair market value, their capital gain would be zero. Because they received a “step up” in basis.
When deciding whether to make gifts during your lifetime or at death, it’s important to compare the potential estate tax savings to the recipient’s capital gains burden.
Other estate tax planning strategies during a recession
In addition to gifting, there are other tax estate planning strategies you should consider during a recession. One option is to take advantage of trusts.
There are many kinds of trusts to address different goals. However, those who want to reduce their estate tax liability may be especially drawn to irrevocable trusts. Assets transferred to an irrevocable trust are removed from your estate. They thus reduce the amount of estate taxes your beneficiaries will have to pay upon your passing. Some common irrevocable trusts include:
- Grantor retained annuity trust (GRAT). This type of trust allows you to transfer assets to the trust in exchange for annuity payments until the trust expires. At the end of the term, any remaining assets in the trust go to the beneficiaries.
- Charitable lead annuity trust (CLAT). With this type of trust, you make fixed payments to preferred charities over the term of the trust. Once the trust expires, any remaining assets are distributed to the beneficiaries.
- Irrevocable life insurance trust (ILIT). This type of trust holds life insurance policies. And you can add conditions around how and when the death benefit is used and by whom.
Customizing your estate plan to fit your needs
Creating an estate plan that fits your needs is crucial for ensuring you pass down your assets to your heirs intentionally. There are a few essential tips to consider when creating an estate plan:
- Prioritize financial security. When creating an estate plan, it’s crucial to prioritize your own financial security. Consider how any gifts you give now could affect your long-term financial stability. You don’t want to be generous now only to turn to your grown children for financial help later if you outlive your money.
- Understand the tax implications. Be sure to understand how each gifting strategy will affect your estate taxes and the recipient’s capital gains obligations before making any decisions. Your tax advisor can help you run the numbers.
- Utilize trusts. Setting up trusts is key for protecting your assets and ensuring they are passed on to the right people.
- Stay up to date with changes in estate and gift tax laws. Congress frequently introduces new legislation that affects estate planning strategies. So it’s a good idea to review your plan every three to five years. Or after a significant life event to ensure it remains in line with your wishes and in compliance with current tax law.
Final thoughts about gifting and estate planning in a recession
Gifting and estate tax planning during a recession are important components of any comprehensive financial plan.
By understanding the available strategies, as well as their potential tax implications, you can ensure that your assets are protected and passed on to your heirs in the most efficient and beneficial way possible.
It’s essential to work closely with an experienced tax professional when considering any gifting strategy. It’s obviously important to understand how it could potentially impact your estate and gift tax obligations.
Feel free to reach out to Alexis and her team with any questions or concerns; our team would be more than happy to help you plan for your future.
And here are some additional tax-related resources!
- 3 Important Things to Know About Our Progressive Tax System
- 5 Ways W2 Physicians Can Lower Their Taxes
- Debunking 7 Financial Myths Overheard in the Doctor’s Lounge
What do you think? Have you create a gifting and estate planning strategy? Do you see a recession as an opportunity to do so? Let me know in the comments below!