Gifting During an Economic Downturn

The COVID-19 pandemic has catapulted the United States into a recession, and many (if not all) of our portfolios have taken a hit.  While one can appreciate the growing concern among families and business-owners, the current economic climate presents a unique opportunity for wealthy individuals to transfer assets to future generations with minimal estate and gift tax impacts.  I provide a brief example of one useful strategy below, although there are many others that have similar effects.

Overview of Current Estate and Gift Tax Exemption Levels

Under current federal estate and gift tax laws, the first $11.58mm you give away during your lifetime (in excess of the annual exclusion amount) or own at your death will be exempt from estate tax.  If you’re married, this $11.58mm exemption amount may be combined with your spouse’s exemption to give you, collectively, an exemption amount of $23.16mm.  Every dollar gifted during your lifetime or owned at death in excess of the exemption is taxed at 40%.  The $11.58mm exemption amount will be roughly cut in half beginning in 2026 unless Congress votes to extend the current legislation.  Without getting too political, the extension of current exemption levels seems unlikely given the tremendous government spending that has been necessary as a result of the COVID-19 pandemic.

Gifting Strategy During Economic Downtown

One obvious, but effective, way to reduce your estate tax liability is to reduce the value of your overall estate.  This can be accomplished by gifting assets to your children or grandchildren (either outright or in trust).  While the initial gift may reduce your $11.58mm exemption amount, the future growth of the assets passes outside of your taxable estate.  Since stock prices are currently depressed, you have the opportunity to gift shares of depressed stock to your descendants, which will reduce the value of your estate.  Once the economy rebounds, the appreciation in value of the previously-depressed stock will pass to your descendants outside of your taxable estate.  As a result, your estate tax liability is reduced.

 Example:

John is a single person with a net worth of $50mm.  He has two children, Amber and Ben, who are both adults.  John’s portfolio is partially comprised of 100,000 shares of American Airlines stock, which is currently valued at $1mm (based on a $10/share stock price).  In February 2020 (before the COVID-19 crisis), the same American Airlines stock was valued at approximately $3mm (based on a $30/share stock price).  

 If John died in 2020 owning the depressed American Airlines stock, he would face an estate tax liability of approximately $15.368mm. The American Airlines stock generated $400,000 of that estate tax liability.

 However, let’s assume that John gifts the 100,000 shares of American Airlines stock to Amber and Ben while the stock price is depressed (at $10/share).  After making the gifts, the stock price rebounds to $30/share.  As a result, John made a $1mm gift, and Amber and Ben each own $1.5mm worth of American Airlines stock. If John died late in 2020 after the stock rebounded, he would have reduced his net worth by $3mm while only making a $1mm gift.  His estate would save approximately $1mm in estate tax.

Conclusion

 As you can see, taking advantage of depressed asset values by making gifts to your descendants can result in significant estate tax savings.  Additionally, making these gifts into trust for the benefit of your descendants can provide them with creditor protection and estate tax benefits.  Furthermore, if you gift assets in trust, you can continue paying the income tax liability generated by the trust, which further reduces your net worth and allows the gifts to grow more rapidly outside of your estate.

 NOTE: The calculations above have been greatly simplified for the sole purpose of showing the benefits of this strategy.  The actual math is more complicated and beyond the scope of this post.  Additionally, one down-side of gifting assets during lifetime is that the beneficiaries of the gift may experience greater capital gains impacts when the gifted assets are sold by the beneficiaries at a later date.