# PWM Gift Tax compunding question

Here is a question & solution straight from the L3 PWM PM book, was hoping someone could help clarify a couple something:

Philippe Zachary is 50 years old and resides in one of the EU countries. He
is working with his wealth manager to develop an estate planning strategy to
transfer wealth to his second cousin, Étienne. Annual exclusions allow Philippe
to make tax-free gifts of €20,000 per year, and gratuitous transfer tax liabilities
are the responsibility of the recipient. Philippe notes that the relevant tax rate
for bequests from the estate is likely to be 60%. He notes further, however, that
gifts (in excess of the €20,000 exception mentioned) made prior to age 70 enjoy
50% relief of the normal estate tax of 60%, for an effective tax rate of 30%. In
addition, Étienne enjoys a low tax rate of 20% on investment income because
he has relatively low income. Philippe, on the other hand, is subject to a 48%
tax rate on investment income. Philippe is considering gifting assets that are
expected to earn a 6% return annually over the next 20 years.

CFA Q1 Considering the first year’s tax-free gift associated with the annual exclusion, how much of his estate will Philippe have transfer

CFA Solution to 1:
In 20 years, the future value (measured in real terms) equals €20,000 × [1 + 0.06(1
− 0.20)]20 = €51,080.56. Note that although the gift was not subject to a wealth
transfer tax, its subsequent investment returns are nonetheless taxable at 20%.

MY QUESTIONS:
A) The CFA solution assumes that the annual 6% return is taxed annually (and thus compounds post-tax). Why? My natural inclination would have been to assume it’s tax after 20 years, which results in an answer of 55,314

Stifle that natural inclination.

If you earn returns each year, you should assume that they’re taxed each year.

ha fair enough. Both situations (100% realized gains every year versus 100% unrealized gains every year) are unlikely, i guess assuming more tax is the conservative assumption.