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    Annual gifts to children can reduce income & estate tax

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    Explain how annual gifts to his children will reduce both his income during lifetime and his estate tax at death. Conduct tax research and formulate tax-planning advice in response.

    Pedro Bourbone is the founder and owner of a highly successful small business and, over the past several years, has accumulated a significant amount of personal wealth. His portfolio of stocks and bonds is worth nearly $5,000,000 and generates income from dividends and interest of nearly $250,000 per year. With his salary from the business and his dividends and interest, Pedro has taxable income of approximately $600,000 per year and is clearly in the top individual marginal tax bracket. Pedro is married and has three children, ages 16, 14, and 12. Neither his wife nor his children are employed and have no income. Pedro has come to you as his CPA to discuss ways to reduce his individual tax liability as well as to discuss the potential estate tax upon his death. You mention the possibility of making gifts each year to his children.

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    Solution Preview

    Tax law currently allows an exemption of 3.5M from the assessment of estate income tax. That means if Pedro were to die today, his estate would be taxed on 1.5M (5M - 3.5M). The maximum rate currently is 45% plus any amount that the state of residence might charge. Resident estate taxes vary widely from nothing to lots. At 45%, his estate could have to pay the IRS $675,000.

    Granted this is an over simplification of the reporting process which may be the most complex area of tax law, and is usually closely planned and reviewed by an estate or tax attorney.

    The plan then is to take steps now to avoid the possible payment of $675,000 later, although we know tax law will change in 2010. Currently, the exemption of 3.5M is set to expire in 2010 and begin again at 1M in 2011. What changes may occur would be speculation at best, but as it stands, Pedro's estate tax on death in 2010 could amount to 2.5M and 2.2M in 2011 .

    Pedro should consider beginning to gift funds to his three children immediately. Assuming Pedro's assets are owned by both husband and wife, each can gift $13,000 to ...

    Solution Summary

    In a 736 word solution, the response focuses on the issues of annual gift tax amounts, estate taxes, current law and expected changes. Further, tax planning for the parents is discussed as the result of several planning ideas presented.

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