How to Share Wealth Without the IRS Getting It All

Whenever something of value changes hands, the Internal Revenue Service is usually going to want its cut.

But if you plan ahead and employ tax-smart strategies, you can make sure more of your wealth goes to your nephew Steve than to Uncle Sam.

Although many people would rather share their wealth with family while they're alive, the IRS often makes this a tall task -- but not impossible.

The Gift of Gifting

The easiest way to share your wealth, of course, is by simply giving money or assets away. There is a limit, however, to how much you can give before the IRS starts taking its cut. And the tax consequences can turn a gift into a burden -- just ask the Oprah audience members who discovered they owed thousands to the IRS after the generous host gave them all cars in 2004.

This year, the inflation-adjusted annual gift tax exclusion is $12,000 per donee (there is no limit if the recipient is a spouse and a U.S. citizen). That means you can give as much as $12,000 to any individual each year without incurring taxes, and there is no limit to the number of beneficiaries.

So you can give to as many people as you want, as long as each one doesn't receive more than the annual limit. In addition to benefiting your loved ones, the added advantaged to gifting is that it also reduces your taxable estate, and thus the estate tax burden on your heirs.

The gift tax rules, however, don't apply only to cash, but to assets such as property and equities. And in some cases this may be even more advantageous than giving away just cash. Because of inflation, cash depreciates in value over time, while stocks have the ability to increase in value. Even if you give away a stock that appreciates, for tax purposes it will be taxed on its market value as of the day of transfer.

A Trustworthy Strategy

Another effective way to share your wealth while limiting your tax exposure is with a grantor retained annuity trust. A GRAT is an irrevocable trust set for a specific amount of time, during which you receive a set annual payment. At the end of the trust's term, the length of which you set, the assets in the trust are passed along to your heirs.

For example, you can create a GRAT and fund it with $500,000 that generates an annual cash flow of $50,000. Under the terms of the GRAT, you receive that annual annuity for 10 years. At the end of the term, the remainder, including any appreciation, is passed along to your beneficiary. However, once established, you can't add to the trust during its term.

Another trust useful for transferring wealth is an irrevocable life insurance trust, or ILIT. This is a trust that takes ownership of your life insurance policy and, like the GRAT, removes it from your taxable estate. On the other hand, if, for example, you have a life insurance policy that pays out $5 million and it is included in your estate, your heirs will be burdened with a hefty estate tax bill.

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