The complex techniques sometimes used in estate planning can feel daunting. Ironically, one of the simplest strategies can be effective for some investors: Utilizing your annual gift exclusion ($18,000 per individual in 2024).
When applied year-over-year, annual gifts can potentially significantly reduce your overall estate tax liability over time. And for those with more significant assets, larger gifts that utilize the lifetime gift tax exemption (in 2024, $13.61 million per individual), can dramatically increase the "after-tax" return on assets passed to your heirs.
However, late-in-life gifting can have traps for the unwary, potentially resulting in disallowed gifts. Below are 5 traps that can spoil last-minute gifting tactics.
1. Gifting during incapacity
When discussing incapacity, the focus is usually on managing health care and the day-to-day financial life of an incapacitated person. But what if a hypothetically incapacitated person made annual exclusion gifts for decades but had not yet this year, was considering a large gift to a trust before the 2026 sunset to utilize the higher exemption, or if their beneficiaries were outdated due to a change in circumstance?
Once incapacitated, the authority of their agent or successor trustee, if any, will determine whether gifts can continue during incapacity. Typically, the agent's authority is broad and includes the ability to undertake any act that the principal could take. However, in some states, the broad authority is restrained unless the document specifically authorizes certain actions. For example, the power to create, revoke, or amend a revocable trust, make expanded gifts, and change beneficiary designations may need to be specifically referenced in the document (these are sometimes known as "hot powers"). In the case of a revocable trust, if it isn't funded before incapacity, then assets may pass through a lengthy and expensive probate process.
For this reason, it's critical that your powers of attorney and revocable trusts empower your fiduciary to carry on your intentions through an established gifting program or update outdated beneficiary designations. Otherwise, when the agent exercises their powers, it might raise suspicion among heirs. In addition, it's important to ensure your fiduciaries are aware of your gifting strategy and understand the intent for future gifts that should be made.
2. The 3-year clawback
Lifetime gifts that utilize your larger exemption can reduce your taxable estate by the amount of the gifted assets, any payment of gift taxes, and any future growth of the asset. However, gifts made within 3 years preceding the death of the taxpayer are often subject to close scrutiny. If the decedent has retained any power or interest in the property, the gift could be brought back into the estate at fair market value at the time of death.
In addition, any gift taxes paid on gifts made within 3 years preceding the death of the taxpayer may be "clawed back" into the decedent's gross estate for estate tax purposes. The aim of this regulation is to prevent deathbed gifts from reducing an individual's taxable estate.
3. Deathbed transfer between spouses
Spouses enjoy certain privileges in estate planning, including a step-up in cost basis on any assets and an unlimited marital deduction. Given that, it can be tempting for one spouse to transfer highly appreciated assets to a dying spouse with the hope of capitalizing on step-up.1 This is especially appealing if their estate plan calls for the deceased spouse's assets to transfer back to the surviving spouse (the original donor).
However, there is an often-overlooked rule in the tax code that prevents basis adjustments when transfers for less than fair market value are made to a decedent within one year of their death and the asset is transferred back to the donor or the donor's spouse. This rule would likely apply to the basis of assets a spouse contributes to a joint trust within one year of death as well.
If you and your spouse have highly appreciated assets, especially if they are owned by only one spouse, consider discussing with a financial professional or estate attorney how to proactively manage basis and not wait until it's too late.
4. Deathbed gifting
For transfer tax purposes, regulations define a completed gift as one for which the donor has "parted with dominion and control as to leave him no power to change its disposition." However, what constitutes a completed gift is often dependent on the facts and circumstances of each case. And state law ultimately controls whether a donor has forfeited the requisite control to constitute a completed gift.
For example, in one recent scenario, a tax court in Pennsylvania ruled that gifts made by checks written 5 days before a donor passed away were not complete, reasoning that at any time up until the donor's death they (or their agent) could have placed a stop-order on the checks.
This scenario is another example of why planning ahead is critical. Those who wait until the last minute may be disappointed to learn that their gift was not "complete" for transfer tax purposes.
5. State gift taxes
It's important not to overlook state rules around gifting. While only one state, Connecticut, currently has a gift tax, several others have similar laws with a different flavor. In New York, the value of gifts made within 3 years of death must be added back into the estate for New York state estate tax computation. And Massachusetts requires the value of taxable gifts to be added back into the value of the estate to determine if an estate tax filing is required, but not necessarily if a tax is due. This may allow the taxing authority the opportunity to examine the return and find reasons—such as any of the above—to alter the tax due.
Gifting can be a powerful estate planning technique, but failure to properly design and execute a gifting program in a timely manner can cost your heirs. Reach out to an estate planning professional to review your gifting strategy and discuss how you can proactively plan to avoid last-minute gifting traps.
David is responsible for Fidelity's estate and wealth planning activities, including creation of new thought leadership in these areas. He heads a team of professionals that develops and delivers the depth and breadth of Fidelity's wealth planning offering.
Prior to joining Fidelity, David was managing director and head of Insured Solutions for UBS Wealth Management Americas. He served as chief operating officer of UBS Wealth Planning. David first joined UBS as a senior member of UBS Private Wealth Management, and was involved in the creation of that business for the firm. During his tenure with UBS, he also served as the chairman and president of UBS Life Insurance Company USA, Inc.; the chairman and president of UBS Financial Services Insurance Agency, Inc.; and a board member of UBS Trust Company, N.A.
Prior to joining UBS, David was a director in Merrill Lynch's Private Banking & Investment Group. He joined the firm's International Private Banking business in London and was a key member of the firm's Corporate Strategy unit.