Question

Jones is seriously ill and has $6 million of property that he wants to leave to his four children. He is considering making a current gift of the property (rather than leaving the property to pass through his will). Assume all of his exemption equivalent was used and any taxable transfers will be subject to the highest transfer tax rate.

Required:
a. Determine how much gift tax Jones will owe if he makes the transfers now.
b. If he makes a current gift, how much estate tax will Jones save if he dies after three years, during which time the property appreciates to $6.8 million?

Answer 1

Without the current gift tax exclusion and applicable tax rates, an exact calculation cannot be made. Assuming a 40% tax rate, Jones would owe $2.4 million in gift tax now and, with property appreciation, save an additional $320,000 in estate taxes, totaling $320,000 in savings.

Step-by-step explanation:

The student's question relates to the calculation of gift and estate taxes under the assumption that Jones will make a current gift of property to his children. To determine how much gift tax Jones will owe if he makes the transfers now, we need to know the highest transfer tax rate applicable and the current gift tax exclusion amount. However, as it was not provided within the question, we cannot calculate the exact tax amount without further information. For the purpose of this example, let's assume a transfer tax rate of 40%, which is often the highest rate for federal gift and estate taxes in recent years.

Assuming Jones gifts the property currently valued at $6 million and his entire exemption equivalent has been used, the gift tax owed will be $6 million multiplied by the 40% tax rate, resulting in a tax of $2.4 million.

Regarding part (b), if Jones makes a current gift and then passes away after three years, with the property having appreciated to $6.8 million, the estate tax savings will be the tax on the $800,000 appreciation. This amount will be saved because the property will appreciate in the hands of his children rather than as part of his estate. Therefore, assuming the same 40% tax rate, he would save an additional $320,000 in estate taxes (40% of $800,000), bringing the total tax savings to $320,000.

This scenario illustrates a strategy where giving a present gift before death can lead to tax savings owing to the appreciation of the transferred assets being outside of the donor's estate. It should be noted that tax laws are complex and subject to change, so specific tax calculations should always be confirmed with updated tax rules and rates or with the assistance of a tax professional.

Answer 2

If Jones makes the transfers now, he will owe $2,376,000 in gift tax. If he dies after three years and the property appreciates to $6.8 million, he would save $1.96 million in estate tax.

Step-by-step explanation:

To determine the gift tax that Jones will owe if he makes the transfers now, we need to calculate the taxable amount of the gift. The taxable amount is the fair market value of the property minus the annual exclusion amount. Assuming that Jones used all of his exemption equivalent, the annual exclusion amount for 2021 is $15,000 per recipient.

Since Jones has four children, the total annual exclusion amount is $60,000 ($15,000 x 4). Therefore, the taxable amount of the gift is $6 million minus $60,000, which equals $5,940,000.

The highest transfer tax rate for 2021 is 40%. To calculate the gift tax, we multiply the taxable amount by the tax rate: $5,940,000 x 0.4 = $2,376,000.

Therefore, Jones will owe $2,376,000 in gift tax if he makes the transfers now.

If Jones dies after three years and the property appreciates to $6.8 million, we need to calculate the estate tax savings. The estate tax is calculated similarly to the gift tax, but the exemption amount for 2021 is $11.7 million. Therefore, if Jones dies after three years, his estate will be subject to estate tax on the difference between $6.8 million and $11.7 million, which is $-4.9 million.

Since the estate tax is applied at the highest transfer tax rate of 40%, the estate tax savings would be $-4.9 million x 0.4 = $-1.96 million.

Therefore, if Jones dies after three years and the property appreciates to $6.8 million, he would save $1.96 million in estate tax.