Hello, I’ve read several forum responses on this subject, but none are really helping it stick for me, so here is my question: Reading #10 Estate Planning in Global Context, Schweser 2016 Book 2 pg. 91
The book says that the numerator is supposed to be the FV to the receiver if gifted now.
So, if the donor gives $100 at a gift tax of 25%, I would expect the receiver to get $75 which would then grow to some FV at the receiver’s rate of return (the [1+rg(1-tig)]^n portion of the numerator).
I understand that gifting $100 allows the donor a tax credit on the estate of $100 * 25% = $25, so it would ultimately reduce estate taxes by $25 * Te.
However, why would we add that estate tax saving to the numerator? Why would the receiver be getting that estate tax saving? Is there an assumption that the donor calculates their tax savings from gifting and gives it to the receiver?
Or, should the RV formulas be considered from the perspective of the donor, as in how do I maximize giving away a portion of my estate. I have been thinking of it in terms of the value the recipient would receive from a gift vs. bequest.
you should really be looking at it from the perspective of relative value of Gifting vs Bequest. In this case the value accrues to the Gift as the Estate value is reduced hence reducing the taxes paid at bequest if left in estate… hope that makes sense.
I know that Tg*Te comes from the estate tax savings due to sheltered gift taxes. However, I don’t understand when/how the recipient gets that gets that sheltered amount (which subsequently accrues at their rate of return).
See what I mean? If you give me $100 and have to pay, wouldn’t I get the value after your gift tax? Where is the consideration that it saves money on estate taxes, and thus I get that too? I can see the donor saving money on estate taxes due to the gift tax, but why does the recipient get that amount?
I have read Schweser and CFAI but still don’t find it clear.
it is an imputed sum - to level set the two options - one where the donor pays the tax, the other where the donee pays the tax.
The last term in the second set of parentheses in the numerator, TgTe, represents the tax benefit from reducing the value of the taxable estate by the amount of the gift tax. In this way, allowing the transfer tax to be deducted from the taxable estate can be viewed as a partial gift tax credit.
The size of the partial gift credit equals the size of the gift times TgTe. For example, consider Akio and Haruko Tochigi—a couple wishing to transfer JPY 100 million to their child. They have a JPY 500 million estate, most of which is taxable. Exhibit 6 illustrates the after-tax outcomes of a JPY 100 million gift made just prior to death or a JPY 100 million bequest made just after death, both of which would be subject to a 45 percent transfer tax. The gift reduces the size of the taxable estate to JPY 400 mil- lion, but the JPY 45 million gift tax further reduces the size of the taxable estate from JPY 400 million to JPY 355 million. Under the gifting strategy, the sum of the after-tax estate and gift is approximately JPY 295 million compared to only JPY 275 million for the bequest. As a result, the gift strategy saves JPY 100 million × 0.45 × 0.45 ≈ JPY 20 million in taxes.
all of this reading works in that way. How do you compare two different options - like this … is what they are trying to do, all throughout.
So this detail was unclear to me as well and restating the CFAI material is not helpful.
It may be useful to think of Te*Tg as a deferred tax credit. Like all deferred tax assets, they can only be applied against future income. To the extent there will be no future transfer from the donor, this credit is worthless. A donor is only supposed to gift excess capital, so there should be some residual wealth to bequeath later. It is through lower estate taxes due on this lower residual amount that you realize a tax benefit in the amount Te*Tg. Hope this helps.