There are many complex solutions to this problem. I often believe in simplicity, and there are few things simpler than a formal, structured gifting plan done at the proper time. Many people are aware of the $14,000 gift tax exemption. A person can give $14,000 to as many people as they please without having to file a gift tax return. This $14,000 also does not count against the total federal exemption of $5.34 million. This means you can give $14,000 to a hundred people, lower your estate value by $1,400,000, and still have $5.34 million left to gift.
The $14,000 is a fine start, but in order to get below the Washington threshold, I recommend the client do some heavy gifting. So long as there is no worry about edging against the federal limit, using up some of the $5.34 million exemption to get under the Washington estate tax level is a sound idea.
The question, though, is what to gift?
The key to this choice is what is known as the cost basis. The cost basis is what you pay capital gains on if you sell an item. What a beneficiary pays when they sell an item depends on whether they inherit it or receive it as a gift. This is because of the "step up basis." Let me illustrate. Your mother and father bought a house in 1955 and stayed with that house through thick and thin. When they bought that house in those halcyon days, they paid $45,000. It just so happens that house is now worth $550,000. If your parents gift you that house, retaining a life interest, your cost basis is the same as theirs. That means if you then sell the house for $600,000, you are paying for capital gains of everything over $45,000. On the other hand, if you inherit the house, you receive a step up basis. Put simply, the basis steps up to the value at which you received it. Now, you are only paying capital gains on $50,000 profit.
The key to gifting is to choose assets that have not increased much in value. Cash will do it. A stock recently purchased will do it. Basically, anything that is worth now what it was worth when purchased.
Gifting is an enjoyable part of estate planning. I like coming up with a game plan. I always tell clients, however, that our game plan is slow and steady. The lesson with gifting is like most other lessons involving taxes: if you get cute, they will get you.