Estate planning: LOS 11.e

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FrankCFA

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LOS 11.e: Explain the estate planning benefit of making lifetime gifts when gift taxes are paid by the donor, rather than the recipient.
Any easy way to explain this one? Must go the complicated Relative After-tax Valuation?
 
There is a tax advantage to give a gift if the tax rate on gifts is less than the tax rate on bequests. However, there can still be a relative advantage to gifting even if these tax rates are the same.If the recipient is taxed at a lower rate than the donor, the value of the asset will appreciate at a higher rate after it is transferred (vs. being held by the donor) because the returns are assumed to be the same but are taxed at a lower rate.
its important to understand and memorize the formula
 
Momorize the formula? Okay…i will try, thanks.
 
I reread the curriculum and to answer the LOS, should be the RV ratio numerator is added “Estate Tax Rate” product “the gift tax rate”.
I hope it’s the answer…although I still don’t know how to derive the equation.
 
think about it in a simple manner.
Someone donates to you a 100$ - and then you (donee) have to pay a tax on it of 20%. You then have 80$ to grow in your portfolio. and subsequently there is an estate tax of 25% on it. You are growing 80$ here.
What if this were reversed - donor paid gift tax, and then gave you 100$ - no taxes to be paid by you. and your portfolio grows and you then pay a 25% estate tax. 100$ grows here…
the 80 vs. 100 is the difference here. (100 happens in the latter case because donor paid the taxes).
 
Many thanks, CPK. I’m thinking how to answer CFA if the LOS is the question directly. Can I use the example as you did to be the answer? Thanks in advanced.
 
no body asks you questions to answer the LOS directly, ever….
please do not be under the mistaken impression that
a. the question would be a direct lift off from an LOS
b. that it will address a single LOS.
be prepared for questions that require you to use your judgement, analysis and data provided
and the questions definitely address multiple LOS’s.
LOSs are just guidelines on the various topics you need to know.
Check the earlier AM examinations. Sorry to be a bearer of this news so close to the exam … but change your method of addressing your review. It is not too late. Look at the various AM exams available, check how you would answer them on your own, look at how the guideline answer (which is way more detailed) answered the same question - and adjust your method accordingly.
 
cpk,
I’m still a little confused about when donor pays taxes. In the numerator, (1-Tax rate of donee+ gift tax rate * estate tax). Why there is a multiplication of gift tax rate*estate taxe rate ??
 
(1 - tax rate of donee) -> this part should be very clear… it is the tax that the donee pays.
If the person were gifted something too - this would apply.
The additional amount that the donee now gets - if the amount of gift tax (that the donor paid) and that he would get after the estate tax is paid. That is the gift tax * estate tax part - whch he now gets to enjoy.
 
Why estate tax comes into play here? It’s gifted so only gift tax applies??!!!
 
I think it’s the benefit the estate gets from gifting away a value of the estate that is no longer going to be taxed.
Edit:
From the text: represents the tax benefit from reducing the value of the taxable estate by the amount of the gift tax.
Tg*Te = Tax on gifts * tax on estate = tax benefit
 
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