While it may not be pleasant to think about and plan for your death, failure to plan can cause unnecessary stress and grief for those you leave behind after you pass away. If you do not create an estate plan and update it regularly, you also expose yourself to stress and loss of peace of mind because of the uncertainty that your wishes and goals will be fulfilled. If you have not updated your estate plan to include loved ones who are not provided for in your existing plan, you may be tempted to make deathbed gifts. It may bring you pleasure to make significant gifts to loved ones because of the joy it may bring to them. However, in addition to the obvious problem that none of us knows the exact time we will die and may not be able to make the deathbed gifts we intend, there are some other drawbacks to deathbed planning that you may not have thought about.
Doubts about Your Capacity
To make a valid gift, you must meet the requirements of state law. For example, in Michigan, the donor making the gift must intend to gratuitously pass title or ownership of the property to the donee recipient; actual or constructive delivery of the property must be made; and the donee must accept the gift. Some states require that the donor have the mental capacity similar to that required to make a valid will: (1) you must have a general understanding of what type and how much property you own, (2) you must understand to whom you plan to give the property, and (3) you must understand that the gift transfers the property. In some states, it may also be necessary for you to have an understanding of the effect of the gift on your future financial security.
If you make a gift on your deathbed, other heirs who may have inherited the property if the gift had not been made and who disagree with your decision may question your mental competency to make the gift. Although the mere fact that a gift was made on your deathbed is not enough on its own to show that you lacked the capacity to make the gift, there may be other factors that call the validity of the gift into question. Could your medical condition at the end of your life cause your mental capacity to decrease? Were you taking medications immediately prior to your death that could impede your understanding?
These questions about the requirements of state law or your mental capacity lead to increased potential for the deathbed gift to be challenged.
Lack of Basis Adjustment
While a deathbed gift may seem special and meaningful, it may come with significant costs to the recipient. Under federal tax law, a capital gain occurs if property is sold or exchanged for more than its original price. The original price establishes the tax basis. If you make a gift during your lifetime, even one minute prior to your death, the recipient of your gift will have the same basis you had, called a carryover basis. However, if the same person inherits the property after your death, the basis of the property is generally stepped up to its fair market value at the time of your death. If the value of the property has increased over time, a lifetime gift, even if made just before your death, exposes the recipient to taxes that could be avoided if the gift were made after your death.
Example: If, on your deathbed, you decide to give your daughter a valuable painting you purchased in 1975 for $20,000 that is currently worth $150,000, the painting has appreciated in value by $130,000. Your daughter ‘s carryover basis in the painting is the same as yours—$20,000. As a result, if your daughter decides not to keep the painting and sells it for $150,000, the increase in value of $130,000 will be taxable as capital gain to her. In contrast, if your daughter inherits the painting at your death, her basis will be stepped up to $150,000, the fair market value on the date of your death. If she immediately sells it, she would have no capital gain, resulting in significant tax savings.
Possible Inclusion in Your Gross Estate
If you have a large estate, you may consider lifetime gifts as a way of decreasing the size of your estate and minimizing your exposure to estate taxes. However, if you wait until you are on your deathbed to make those gifts, they will still be included in your estate under some circumstances because they are not considered “completed” gifts under federal tax law (I.R.C. § 2035(c)(3); Treas. Reg. § 25.2511-2(b)). A recent case, Estate of DeMuth v. Commissioner, dealt with a situation in which a father’s health began to worsen. His son, as his agent under a power of attorney, wrote eleven checks on September 6, 2015, from his father’s investment account totaling $464,000 to different recipients, attempting to take advantage of the annual gift exclusion, which was $14,000 in 2015. The father died on September 11, 2015. Some of the recipients had deposited their checks before the father’s death, but some had not.
Treasury Regulation § 20.2031-5 provides that the “amount of cash belonging to the decedent at the date of his death, whether in his possession or in the possession of another, or deposited with a bank, is included in the decedent’s gross estate.” The Tax Court found that under the applicable Pennsylvania law, delivery of a check does not complete the gift. Instead, only checks deposited by the recipients before the father’s death and credited to the their bank were completed gifts, and those that were not deposited or paid by the investment company should be included in the father’s estate because he (or his son as his agent) could have stopped payment on those undeposited checks until his death. Estate of DeMuth highlights the importance of planning ahead rather than waiting until the last moments or days of life to make a gift, particularly if the goal is to reduce your estate tax liability.
The laws in this area are tricky. Careful planning is needed. For example, gifts made within three years of your death are generally includible in your estate, under I.R.C. § 2035(a). However, there is an exception if a gift tax return was not required to be filed because the value of the gift was less than the annual exclusion amount. But, transfers relating to life insurance policies are an exception to this exception under I.R.C. § 2035(c)(3). These subtle nuances may be missed with deathbed planning.
We Can Help You Plan Ahead
The downsides of deathbed planning can outweigh any benefits you may think it will achieve. It is prudent to consult an experienced estate planning attorney when considering any plan involving lifetime gifts. Creating an estate plan designed to achieve all of your goals or updating an old plan that is no longer in line with your wishes will help to avoid family discord and avoid unnecessary tax bills. In addition, you will have the peace of mind that comes with knowing that your intentions will be carried out. Schedule time to meet with us so we can assist you in planning ahead to avoid additional grief for you and your family.
