Making Gifts to Your Granddaughter's Future Ex-Husband

Posted on September 9, 2009 by Bryan Howard

Wealthy grandparents often make gifts to their grandchildren. A grandparent can give $13,000 per year to each grandchild without incurring gift tax. If gifts are made over several years, estate taxes upon the death of the grandparents can be substantially reduced.

There is a hidden trap in making gifts. The danger is that your grandchild may get divorced in the future. Some states consider all property owned by either spouse to be marital property which is subject to a 50/50 division upon divorce.

The problem is illustrated by a family that I now represent. The grandmother made gifts of stock of the family business to her granddaughter in the 80s and 90s. The grandmother died in 1997. Two years later, her granddaughter married a man the grandmother never met.

I did not know the grandmother, but have represented the grandmother’s daughter for the last several years. The daughter continued her mother’s pattern of making annual exclusion gifts to her daughter. Rather than direct gifts, the gifts were made to a Cristofani Trust (pdf) that benefits the daughter’s husband and all of her children and grandchildren.

The granddaughter recently obtained a divorce in a state that treats all property owned by either spouse as marital property. In accordance with state law, the judge awarded one-half of the granddaughter's stock in the family business to the granddaughter’s husband.  The net result is that when the grandmother made gifts to her granddaughter, she was also making a gift to her granddaughter’s future ex-husband.

The stock awarded to the ex-husband was subject to a Shareholder’s Agreement, which allowed the company to purchase the stock from the ex-husband. As you might imagine, the family was upset about having to buy back the stock.

The laws of the states where the grandmother and granddaughter lived at the time of the gifts would not have included the gifts in the marital estate if the granddaughter had obtained a divorce in either one of those states. However, division of property is determined by the state in which the couple resides at the time of the divorce.

Fortunately, because the gifts by the daughter were made to a trust, these gifts were protected in the divorce. The moral of this story is to consider making gifts to a properly designed trust in order to reduce the chance that the donee will lose part of the gift if they subsequently obtain a divorce in the wrong state.
 

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529 Accounts Not Always Good Fit for Affluent Families

Posted on August 31, 2009 by Bryan Howard

529 Accounts allow a family to set aside funds for the education of their children or grandchildren without having to pay income tax on the earnings of the plan. These accounts work well for the great majority of families. However, I often discourage my clients from establishing 529 accounts.

In order to avoid paying income tax on the earnings of the 529 account, the funds in the account must be used to pay for expenses of attending college. Tuition accounts for the largest portion of these expenses.

Federal and state gift tax laws allow individuals to pay tuition for another individual without such payment being considered a taxable gift. Tuition payments allow parents and grandparents to reduce the amount of their estate that will be subject to estate taxes upon their death.

Assume that a wealthy grandparent makes gifts to a 529 account for the benefit of a grandchild. Gifts by the grandparent to the 529 account are considered taxable gifts. Generally, the grandparent uses the $13,000 per year annual gift tax exclusion when making gifts to a 529 account.

When the grandchild attends college, the 529 account will be used to pay for the grandchild’s college expenses. The net result of the above example is that the grandparent “lost” the opportunity to make tax-free gifts of the grandchild’s tuition.

If the annual exclusion gifts to the 529 account had instead been made to a traditional brokerage account for the grandchild, the grandparent could have paid tuition without utilizing the funds in the brokerage account. The grandparent’s taxable estate would be reduced and the grandchild would have funds that could be used to make a down payment on a house or to supplement the child’s cash flow when entering the work force.

It is true that income taxes would have been paid on the earnings of the traditional brokerage account. However, this income tax cost does not offset the estate tax savings from being able to make a tax-free gift of tuition expenses. Furthermore, 529 accounts have internal fees and are restricted as to investment choices. These fees and investment limitations somewhat dilute the income tax savings associated with 529 accounts.

Affluent families should evaluate the overall tax ramifications before funding a 529 account to fund a child or grandchild’s college education.

For more information on 529 accounts, you can visit this link.
 

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