It seems contrary to common sense that “ paying early ” is cheaper than paying later. Part of the reason for this is that gifts may often be planned in advance with assets passing at a discounted or low value. But there are also several other reasons why paying gift taxes can be cheaper than paying estate taxes:

¨   The gift tax rate is about half of the estate tax rate at death, even though the two taxes nominally have the same tax brackets for a given amount of assets. The gift tax is actually much lower because it is applied only to the value of the actual gift, and not to all the assets you own, which would include the assets in fact used to pay the tax. Thus, if you are in the 50% gift and estate tax bracket and you want to give someone $100,000, the gift tax is $50,000 vs. $100,000 in estate taxes.

¨   The investment return on gifted assets escapes both gift and estate taxes. Thus it can be cheaper to pay gift taxes early rather than deferring taxes until death and paying estate taxes. Let’s look at a very simple example to understand how the math works. Assume that the gift and estate tax rates are actually the same. (As we have seen above, gift tax rate is effectively lower. But assume now that the effective rates are the same, so we can illustrate another point.) Suppose you are in the 50% wealth tax bracket and own a $1,000 pool of assets that you want to transfer, and the assets will double in value if properly invested. By making a gift you would pay 50% in transfer taxes now ($500) and the remaining $500 would grow to $1000. Instead, you can defer the tax and let the $1000 grow to $2000 during your life and then pay the 50% tax at death through an estate tax. Either way you end up with $1000 after tax, even if the rates were the same in both cases. So don’t assume that estate taxes are cheaper because they are deferred.

 Gift taxes are not always cheaper, however:

¨   Paying gift taxes requires cash. Obtaining cash frequently results in triggering income taxes. (Raising cash for estate taxes usually does not trigger income taxes)

¨   If the gift is made and the gift tax paid, the gift will not seem like much of a bargain if the gifted property unexpectedly drops in value.