Gifts to Children – Making Them More Effective

February 27, 2020

Gifts are made to loved ones for many reasons.  Parents may just want to give their children financial help or accomplish other worthwhile objectives.  Well-planned gifts can reduce a donor’s estate for estate tax purposes and shift income taxation to or away from the recipient of the gift.  Many objectives can be addressed in a comprehensive plan.

Gifts to children are nonmarital property and, as such, may be protected from divorce claims.  Preserving nonmarital status is an important consideration in transferring family wealth.  Transfers to children can be done in many ways and some transfers accomplish estate and asset protection goals better than others.  For a gift to be effective for tax purposes, the transferor cannot attach any conditions to the gifts, but that does not prevent parents from possibly “encouraging” the child to use the cash in a specific manner.  Below, are some of the available strategies to transfer assets to loved ones.

Outright Cash Transfer

A child can receive a cash gift that is simply deposited into an account owned by the child.  If the account is co-owned with the child’s spouse, the gift is “commingled” and no longer has the protection of nonmarital status.  So, the child is usually well-advised to keep all gifts in a separate account in the child’s name only.

Roth IRA

Perhaps parents desire to make a gift with more of a purpose.  Cash can be deposited into a child’s traditional or Roth IRA.  By doing so, the parents’ gifting strategy takes on the additional aspect of helping the child with retirement planning.

Gifts to In-laws

Often, parents like to expand gifting to include their children’s spouses.  Parents may welcome more potential recipients so they can diminish their estate faster for estate tax purposes.  One strategy is to encourage the in-law to use the gifted cash to invest in an asset co-owned by the in-law and the parents’ child, such as a joint brokerage account.  The cash can also be used to pay down a mortgage, which creates more equity in the child’s marital home co-owned by the parents’ child.

Brokerage Account

A gift can be made into a child’s separate brokerage account that is invested for the long term.  With proper counseling and planning the child should view the account as long-term in nature and to be used for retirement or other prudent investments.

LLC interest

If parents are concerned that gifted assets will be misused, one idea is to create a limited liability company (LLC) and place financial assets into the LLC.  A child can be gifted LLC member interests, which are different than the underlying assets.  Control over LLC assets can be vested in a child or other trusted person who acts as the manager of the LLC’s affairs.

Gift Trust

A more involved strategy is for parents to form a gift trust for each person they desire to make gifts to as part of a long-term plan.  Trusts can have significant advantages including asset protection, income and estate tax savings.  A significant advantage of gift trusts is the potential to have the parents pay the ongoing income liabilities of the trust essentially allowing the trust to grow income tax-free to the child beneficiary.

Summary

Parents know their children will ultimately inherit wealth.  Careful gift planning can help children and also address important financial and asset protection goals.   A well-executed gift strategy can be critical to efficiently passing on wealth to future generations and provide parents insight into how their children will handle gifted wealth.

Michael C. Foltz, JD, CPA, CFP® is a BDF founding principal and founder of our Business Owner Team with an extensive background in law, tax and estate planning.  Mike shares his estate planning expertise by following the ever-changing federal and state estate tax laws and preparing education summaries for clients and team members.  Recognized by Chicago magazine as a Five Star Wealth Manager, Mike has given numerous presentations on estate planning to BDF clients and professional organizations such as the Exit Planning Institute and Illinois State Bar Association. Publications such as Inc. magazine and the Wall Street Journal have featured his insights into estate planning, and he has contributed to an estate-planning publication for Commerce Clearing House.