The Great 2012 Gifting Opportunity - Part 4: Will A Large Gift Demotivate Your Children?
This is the fourth article of a series designed to provide guidance for those individuals who are considering making a large gift in 2012 to take advantage of the $5.12 million federal gift tax exemption that will expire at the end of the year. For the first three articles in the series, see:
In addition to tax savings, gifts can provide a lot of positive benefits for the donees. For example, consider a child who is divorced and having to work two jobs to make ends meet. A gift might enable your child to give up the second job and spend more time with your grandchild.
Gifts also have potential downsides. A lot of our clients worry a great deal about the effect that a large inheritance will have on their children. They like the idea of their children being motivated to become productive members of society. They fear that their children may not reach their full potential if they do not have to work.
Heretofore, the primary time when this issue has been relevant was when our clients were planning their estates. Some clients create strict trusts in their Wills that match the child’s earnings from their work. Other clients choose to give most of their entire estate to charity, making only modest bequests to their children.
Our clients have not previously worried much about the effects of a large gift because federal and Tennessee gift taxes stopped them from making large gifts. However, the ability for a married couple to give $10.2 million without paying any federal or Tennessee gift taxes in the calendar year 2012 has caused our clients to focus on this issue.
If you are concerned that a large gift might negatively impact your children, you should make the gift to a trust and/or give noncontrolling interests in business entities. A trust helps in several regards. First, the trustee will be in control of investing the funds and making distributions. Second, Tennessee allows “secret” trusts. Your children do not have to know about the existence of the trust or the assets owned by the trust. You can designate a representative to receive any required notices concerning the trust. Third, if you are married, you should consider making your spouse the primary beneficiary of the trust. Your spouse can also be the trustee of the trust. Your children do not have to receive distributions from the trust. Fourth, your spouse or some other person can be given a power of disappointment that can be used to make changes to the trust in the future. For example, if one of your children “leaves the reservation”, that child could be disinherited as a beneficiary of the trust. Fifth, we generally recommend making the trust a grantor trust for income tax purposes. Even if your child receives a distribution from the trust, he or she will not receive a K-1 which might reveal information about the trust.
Another method for limiting the consequences of a gift is to give nonvoting stock, nonvoting interests in a limited liability company, or limited partnership interests. These assets are difficult to sell. Furthermore, the owners with voting control will determine the distribution policy of the company and the level of salaries paid to key officers. Your children may be rich on paper, but they will need to keep working if they want to put food on the table. Incidentally, these types of assets typically receive valuation discounts of 35% or more due to illiquidity and lack of control. The discount allows you to make a larger gift.
Making a large gift may lead to unintended consequences. You can minimize these consequences by giving particular types of assets or by making the gift to a properly designed trust.