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Your client can fund trusts with either completed or incomplete gifts. How a trust gets funded can impact both the client and their heirs' future tax liabilities. That is why trust funding should reflect client goals.

Read on to learn about some of the distinctions between completed and incomplete gifts.

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Reducing Estate Taxes with Completed Gifts

With a completed gift, the gifted asset no longer belongs to the client but to the trust itself – an independent tax entity. Given ownership by the trust, the gifted asset's future investment return is similarly no longer taxable to the settlor but to the trust. Finally, with the trust now holding ownership of the asset, your client’s estate is smaller and all of the growth of the asset is outside of their estate as well.

To mitigate estate taxes, make a completed gift of assets with the highest appreciation potential.

Thus, for those with sufficient resources to live out their lives and are looking to reduce their estate's size, it may make sense to make a completed gift of those assets with the highest potential for appreciation.

Lack of Asset Control with Completed Gifts

One caveat of completed gifts: making a completed gift forfeits asset ownership and accompanying asset control.

Step-Up in Basis for Incomplete Gifts

Unlike completed gifts, incomplete gifts remain in your client’s estate. So, while funding a trust with an incomplete gift will not reduce the size of a settlor’s estate, it will allow heirs to inherit assets with a step-up in basis. With a stepped-up basis, heirs inherit appreciated assets – and can sell those assets immediately – without owing capital gains taxes.

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Jeffrey: Let's get into estate state tax for a second. So estate tax, scratch the word from your mind about Grantor non-grantor. The word that my teammate here used, completed gift. So it's either a completed or an incomplete gift. So Grantor non-grantor, completed/incomplete gift. Describe for me if you would, the completed versus incomplete gift.

Ann: Control. I mean it really goes back to control. If I give you a gift a true gift with no strings attached. That's a completed gift. Okay. That's what we expect of Santa Claus,

Jeffrey: Right. Okay, that's a good point.

Ann: And so if I give that completed gift, we give a brokerage account to a trust and we have released all of our control over that, we can't pull it back out. We can't manipulate it however we want and do anything that we would do if we were an owner of it. We have given it away to a trust that now exists on its own. We have completed a gift therefore the IRS cannot consider it ours.

Jeffrey: Okay, so completed gift because the IRS can't consider it ours, is out of my estate.

Ann: Absolutely.

Jeffrey: Okay. Alright, so think of it as a new tax payer if it's a completed gift. It's out of your estate and whatever blossoming occurs if I gave something, a private Equity, or a publicly-traded brokerage account, or a piece of real estate, and it became worth 10 times, 20 times, 50 times more, a year, or five years, or ten years down the line, none of that was in my estate. correct?

Ann: That's right.

Jeffrey: Wow, okay, so you can see why wealthy families who have enough.  resources to live out their life, may want those blossomings to occur outside of their estate. So if that's a completed gift, an incomplete gift therefore is something that didn't get out of my estate. Is that a fair way to look at that?

Ann: That's right.

Jeffrey: Okay, and so the argument that I heard here used about completed or incomplete gift, the only reason not to have a completed gift, for families that have enough resources, is oh my goodness, you don't get the step-up in basis. Okay, so let's let's dissect that one for a moment. So I described that to families as, it's true. If you die and you live in a community property State there is a step-up in basis that gets to occur. So if Ann and I are married and I die and we have a very low basis asset when I'm dead, the income tax basis, the capital gains tax gets eliminated because the asset gets stepped up then when she sells it or the heirs end up selling it when she and I are both dead, then the heirs get to eliminate that capital gain. That's the biggest benefit to keeping it in your state and having it be an incomplete gift. Because when it goes out into that trust and it's a completed gift the cool thing is when they blossom it's not in your estate, but when I'm dead  the trust didn't die. Therefore there is no step up. Is that a fair way to describe that.

Ann: It is and I think it's one of the main points that we boil it down to is the step-up in basis between the completed and incomplete gift. There's other reasons people like to have control over assets, but from the income or the estate tax issue. That's the driver. Does it really matter that we've lost the step-up in basis.

Jeffrey: Okay. All right, and the way I've seen crafty lawyers that I am super impressed with draft cool features into these completed trusts is with the substitution of assets provision. So spend 30 seconds and describe, what is a substitute of assets provision?

Ann: If you're living in both worlds, you have an irrevocable trust with an incomplete gift in it, let's say it's 5, 10, 15 years down the road, and you have retained the power to look into, to peer into that trust and see what is there and then to look at your life situation, and if your life situation says it would be better to have that asset in the trust and that asset out of the trust or to do something where you're smarter about what the step-up in basis should be upon one of your passing, you can reserve the right to exchange assets or let's just say trade assets. There's different ways to do it between the two trust so that you don't lose the step-up in basis, you pull an asset out of the irrevocable trust that has a basis issue and you "enjoy that", so to speak, upon someone's passing. You could preserve that by having a substitution of power. But remember, in doing that you have elected to hold just enough control over that trust that it is not a completed gift.

Jeffrey: Okay,

Ann: Makes sense?

Jeffrey:  Yeah, okay. That's very helpful.


This document is provided for informational purposes only by Dunham & Associates Investment Counsel, Inc. solely in its capacity as a Registered Investment Adviser and should not be construed as legal and/or tax advice. Dunham & Associates Investment Counsel, Inc. does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.