The effect of timing of property transfers on tax savings for estate planning

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FACULTY WORKING
PAPER NO. 818

The Effect of Timing of Property Transfers on
Tax Savinas for Estate Planning

Karen S. Hreha

BUM 1 6F I

Coiiege of Commerce and Business Administration
Bureau of economic and Business Research
University of Illinois, Urbana-Cnampaicn

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BEBR

FACULTY WORKING PAPER NO. 818

College of Commerce and Business Administration

University of Illinois at Urbana-Champaign

December 1981

The Effect of Timing of Property Transfers
on Tax Savings for Estate Planning

Karen Kreha, Assistant Professor
Department of Accountancy

Abstract

This paper presents a summary of the tax effects of making lifetime
property transfers under conditions of uncertainty. Since the time of
death is only an estimate, the risk involved when a transfer is made at
suboptimal times was analyzed.

Simulation was used to generate 24 random samples in which the time
of the property transfer was varied. Sensitivity analysis was performed
with respect to the type of property transferred, size of the estate and
percentage ownership of the property by each spouse.

In general, the findings were that lifetime transfers result in tax
savings regardless of the time the transfer is made. The major exception
is the case in which the property is owned solely by the first spouse to
die and is transferred shortly before his death.

The Effect of Timing of Property Transfers
on Tax Savings for Estate Planning

This paper presents a summary of the tax effects of making life-
time property transfers under conditions of uncertainty. Since the
time of death is only an estimate, the risk involved when a transfer is
made at suboptimal times was analyzed in the following manner.

Case #1

Eight samples consisting of 100 simulations in each sample were
obtained for the case in which both spouses own 50% of the property
under consideration. The tax savings factor computed in each simula-
tion represents the percent of the gift property value which may be
saved (or paid) in taxes by making a lifetime as opposed to an at-death
transfer. Sensitivity analysis was performed by varying the time the
transfer is made from one sample to the other.

The following hypothesis was tested for each sample:

Ho. : Under the current stepped-up basis provisions, there
are no tax savings from making lifetime transfers.

Ha^ : Under the current stepped-up basis provisions, there
are tax savings from making lifetime transfers.

A one-sided nonparametric sign test was applied to the data. The level

of significance at which the null hypothesis is rejected is presented

in Table 1. The median tax savings factor (or tax increase) is also

shown.

In each sample, the null hypothesis is strongly rejected. In other

words, a lifetime as opposed to an at-death transfer should be made to

save taxes regardless of the time the property is gifted. A comparison

No. of
Is Transfi
of 1

Years Property
jrred Before Dea
•"irst Spouse

th

Median
(or
from
as
At-

Tax Savings Factor
• Tax Increase)
Making Lifetime
: Opposed to
Death Transfer

Level of
Significance
at which
Null Hypothesis
Is Rejected

3

(Sample 1)

10.25%*

< .0002

10

(Sample 2)

10,23%

< .0002

20

(Sample 3)

13.01%

< .0002

30

(Sample 4)

11.51%

< .0002

40

(Sample 5)

9.38%

< .0002

50

(Sample 6)

8.61%

< .0002

60

(Sample 7)

9.97%

< .0002

70

(Sample 8)

Table

9.19%

1

< .0002

Property

is

Owned 50% by Each Spouse

*Stated in terms of percentage of value of gift property,

-2-

of the median tax savings factors reveals a slight decrease in tax
savings when property is given away early in life (40 or more years
before death). However, the difference between the smallest and largest
median tax savings factors is only 4.4% (13.01% - 8.61%) of the value of
the transferred property.

Case #2
Eight more random samples consisting of 100 simulated values in
each were obtained for the case in which the property under considera-
tion is fully owned by the first spouse to die. In three of the
samples, a median increase in taxes occurs when a lifetime transfer is
made. See Table 2. The null hypothesis is strongly rejected in two
samples: (1) the time of transfer is 50 years before death and (2) the
time of transfer is 70 years before death. The median tax savings are
2.69% and 2.63% of the property's value, respectively. Considering the
magnitude of savings, the highly improbable transfer times and the risk
of having to pay additional taxes, it is not advisable to make lifetime
transfers when the property is fully owned by the first spouse to die.
The property should be transferred to the children through the decedent's
estate.

Case #3
Once again, eight random samples of 100 each were obtained for the
case in which the property is fully owned by the surviving spouse. The
results are shown in Table 3. In each sample, the null hypothesis is
strongly rejected and lifetime transfers should be made sometime during

No. of Years Property

Is Transferred Before Death

of First Spouse

Median Tax Savings Factor

(or Tax Increase)

from Making Lifetime

as Opposed to

At-Death Transfer

Level of
Significance
at which
Null Hypothesis
Is Rejected

3 (Sample 1)

(6.57%)*

> .9998

10 (Sample 2)

(3.14%)

< .5026

20 (Sample 3)

0.73%

< .3446

30 (Sample 4)

2.07%

< .1587

40 (Sample 5)

(0.11%)

< .5228

50 (Sample 6)

2.69%

< .0007

60 (Sample 7)

1.09%

< .3446

70 (Sample 8)

Table

2.63%
! 2

< .0228

Property is

Owned

Solely

by First Spouse to

Die

*Stated in terms of percentage of value of gift property.

No. of Years Property

Is Transferred Before Death

of First Spouse

Median Tax Savings Factor

(or Tax Increase)

from Making Lifetime

as Opposed to

At-Death Transfer

Level of

Significance

at which

Null Hypothesis

Is Rejected

3

(Sample

1)

26.22%*

< .0002

10

(Sample

2)

24.82%

< .0002

20

(Sample

3)

21.84%

< .0002

30

(Sample

4)

19.40%

< .0002

40

(Sample

5)

16.60%

< .0002

50

(Sample

6)

15.13%

< .0002

60

(Sample

7)

14.01%

< .0002

70

(Sample

8)

12.25%
Table 3

< .0002

Property

is

Owned Solely by Surviving Spouse

*Stated in terms of percentage of value of gift property.

-3-

life. Upon examination of the median tax savings factors, it appears
that the closer the gift is made to the time of death, the greater the
potential tax savings.

In summary, the greatest tax savings result when property is given
during life which is fully owned by the surviving spouse. At the time
of the gift, however, it is not known with certainty which spouse will
die first. If the property which is gifted is fully owned by the first
spouse to die, the potential tax savings are minimal and the risk of
having to pay more taxes is substantial. The risk/return decision
should be evaluated for cases in which the property to be transferred
is owned solely by one spouse.

On the other hand, for the case in which property is owned 50% by
each spouse, lifetime transfers should be made. Although the potential
tax savings are less than in the situation where the property is owned
solely by the surviving spouse, the risk of paying additional taxes is
negligible regardless of the time of transfer or which spouse dies first.

D/5B

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