Tag Archives: annual gift tax exclsuion

Gift taxes

Taking advantage of “gifting” can be a way for you to reduce the size of your estate tax bill and can benefit you and your children and grandchildren.  A regular gift-giving program can result in substantial cumulative transfers of assets over the years.

If you have a substantial estate, “gifting” can reduce the taxable value of your estate and reduce the amount of estate taxes owed when you die.  Under existing estate tax rates, every dollar you can move out of your estate could save your heirs up to forty-five cents if you died in 2008.

Gift tax laws allow you to give away a certain amount of money each year tax-free.  The gift tax laws are comprised of three sets of tax giving rules: the annual gift tax exclusion, direct gifts for education and medical expenses and the $1 million tax-free gift allowance.

What is the annual gift tax exclusion?
Are direct gifts of tuition and medical fees part of the annual gift tax calculations?
What is the $1 million gift tax allowance?
Why can’t you give away all your assets and avoid paying any estate tax?
Are gifts between husband and wife reportable?
Are there any tax reporting requirements for gifts?
How is your estate tax exposure affected by the value of gifts that you give?

Annual gift exclusion

Q. What is the annual gift tax exclusion?
A
. Each of us is allowed to give a certain amount of cash or property to an unlimited number of recipients tax-free each year.  In 2006, 2007 and 2008, the annual gift allowance was $12,000 for each person.  The amount of the gift tax exclusion is set by the IRS and is adjusted each year.

These gifts are not income to the recipient, nor do you get a tax deduction for them.  You can give amounts up to the amount of the gift allowance to as many people as you want, without triggering the gift tax.

A Family Story: Tax-Free Gifts.

Ross and Jessica are married.  They have twin grandchildren, Eric and Clark, who are sophomores in college.  In December 2006, Ross gave Eric $12,000 and Clark $12,000 as a Christmas present.  Jessica also gave Evan $12,000 and Clark $12,000 as a Christmas present.

The gift tax exclusion rule allows everyone to give away $12,000 each year to multiple recipients.  None of these gifts trigger a tax event for the recipients, so Eric and Clark do not have to report the gifts as income or pay income taxes on the gifts.  Ross and Jessica get no tax deduction, but have reduced the size of their taxable estate by $48,000, potentially saving $21,600 in estate taxes.

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Direct gifts for education and medical expenses

Q. Are direct gifts of tuition and medical fees part of the annual gift tax calculations?
A. No. In addition to gifts, you can pay certain educational and health related expenses on behalf of others with no tax consequences.  The gift tax laws allow you to make a direct payment to an educational institution for tuition on behalf of your children or grandchildren.  To be considered tax-free gifts payment must be made directly to the educational institution and must be for tuition only.

You can also pay certain medical expenses, including medical insurance, diagnosis and treatment of diseases, but these payments also must be made directly to the care provider or insurer.

A Family Story: Tax-Free Gifts.

Jeff and Annie are married.  They have two children, Joe and Emma.

In January 2007, Jeff decided to pay Emma and Joe’s tuition.  Jeff sent a check for $10,000 directly to Stanford to pay for Emma’s tuition and another check for $10,000 to pay for Joe’s tuition.

In January 2007, Emma was involved in an accident and incurred $5,000 of medical bills.  Annie made a check payable to the hospital where Emma was treated in the amount of $5,000.

In December, 2007, Jeff gave $12,000 to both Emma and Joe as Christmas gifts.  Annie also gave Emma and Joe both$12,000 as Christmas gifts.

In the year 2007, Jeff and Annie made total gifts of $73,000 – $20K for tuition, $5K for medical expenses and $48K as gifts.

None of these gifts triggered a tax event for the recipients.  Joe and Emma do not have to report any income on their tax returns.  Jeff and Annie gave away $73,000, saving thousands of dollars in estate taxes.

None of these gifts are considered part of Jeff’s or Annie’s $1 million gift tax allowance.

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$1 Million gift allowance

Q. What is the $1 million gift tax allowance?
A. The gift tax rules also include a lifetime $1 million gift tax allowance, giving us the right to give away $1 million of our money while we are living without having to pay any gift tax.

  • The $1 million gift tax allowance is in addition to the free gifts you can make using the annual gift tax exclusion rules and the direct payment of tuition and medical expenses.
  • The $1 million of gifts can be made in multiple years and to multiple individuals.

Why would you want to give away $1 million before you die?  The reason is simple – to get it out of your estate and into the hands of your heirs.  If you keep the $1 million, it will be subject to estate tax rules.  If you give it to your children, neither the principal nor the growth will ever be subject to your estate taxes.

A Family Story: $1,000,000 Tax Free Allowance

Sheldon started an internet company when he was very young, which was subsequently acquired by a Fortune 1000 company.

Sheldon decided to give his two adult children, Samuel and Samantha, the benefit of his entrepreneurial success while they were young, rather than after he died.

Sheldon gave Samantha and Samuel each $500,000 from the proceeds of the sale of the company, taking advantage of his $1 million lifetime gift tax allowance.  Samuel and Samantha do not owe taxes on the $500,000.  Sheldon gets no tax deduction, but has reduced his taxable estate by $1 million.

The personal estate tax exemption allowed when someone dies is a combination of the gift tax and the estate tax exemption allowance.  Since Sheldon used his $1 million gift tax allowance while he was living, his estate must deduct $1 million from his personal tax exemption allowance.  If Sheldon dies in 2009, his personal federal estate tax exemption would normally be $3.5 million.  Since Sheldon has used his $1 million lifetime gift tax allowance, Sheldon’s estate representative can only claim a $2.5 million personal estate tax exemption.

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Q. Why can’t you give away all your assets and avoid paying any estate tax?
A. The IRS provides a life time gift tax allowance of $1 million.  If the cumulative total of your gifts exceeds $1 million you must pay a gift tax.

  • Adding a joint tenant to real estate is considered a taxable gift if the new joint tenant has the right under state law to sell his interest and receive half of the property.
  • Adding a joint tenant to a bank or brokerage account or to a U.S. Savings bond is not considered to be a gift until the new joint tenant withdraws funds.
  • If you purchase a security in the names of the joint owners, rather than holding it in street name by the brokerage firm, the amount of the transaction would be considered a taxable gift.

The gift tax rate in 2008 is 45% of any gifts given in excess of $1 million.

You will pay taxes if you make excessive gifts before you die, or you will owe estate taxes if the property is part of your taxable estate when you die.

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Q. Are gifts between husband and wife reportable?
A. Gifts of any amount between husband and wife are not reportable providing they are both U.S. citizens.

You must file a Form 709 Gift Tax return if you gave a non-citizen spouse over $125,000 in a single year.  The $125,00 is referred to as the Annual Tax Exclusion Amount.  The Annual Tax Exclusion Amount is set by Congress and changes each year.  In 2008, the exclusion amount is $125,000.

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Q. Are there any tax reporting requirements for gifts?
A. If you make a gift of more than $12,000 you need to file IRS Form 709, U.S. Gift (and Generation Skipping Transfer) Tax Return, which is due April 15 of the following year.  You owe no gift tax unless the cumulative total of your excess gifts exceeds your lifetime $1 million gift tax allowance.

You can continue making gifts to individuals in excess of the $1,000,000.  Once your lifetime gift tax allowance is used up, you pay a gift tax when you file your Form 709.

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Q. How is your estate tax exposure affected by the value of gifts that you give?
A.If your annual gifts did not exceed $12K to any one person:

You do not need to file Form 709 when you complete your tax return.  Your gifts do not exceed the $12K a year limit and have no impact on the calculation of your estate taxes.

If your annual gifts to one person exceeded $12K:

You need to document the gift on Form 709 and file it with your 1040 tax return.

Save a copy of the 709 tax return with your estate filing system.

When someone is calculating your estate tax, they will need to deduct the amount of the gifts made exceeding $12K per person per year from the federal personal tax exemption allowance.

Remember that the gift tax is not repealed in 2010 although the tax rate is reduced to 35%.  In 2011, the gift tax rate reverts to 55% unless Congress changes existing law.

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Estate and Gift Taxes

WHAT IS THE FEDERAL ESTATE TAX?

Benjamin Franklin once said, “In this world nothing is certain but death and taxes.”  Boy was he right.  When you die, a special tax known as the estate tax comes into effect.    Currently, less than 1% of the U.S. population owes federal estate taxes when they die.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).  The EGTRRA laws governs the estates of someone who died between January 1, 2002 and December 31, 2010.  The 2010 Tax Relief Act governs the estates of someone who dies between January 1, 2010 and December 31, 2012.   Unless Congress passes new laws, someone who dies after December 31, 2012 must follow the rules in place in 2001.

The discussion below regarding estate tax is applicable in all calendar years except the year 2010.    The last section below describes the special rules for someone who dies in the year 2010.

Q. What is the federal estate tax?

A. The federal estate tax is a tax levied when the taxable value of all of your assets is in excess of the personal estate tax exemption allowance.

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Q.   What is the federal personal tax exemption allowance?

A Federal laws allow you to transfer a certain amount of assets tax-free to your heirs when you die, referred to as your personal tax exemption allowance.

Q. What is the amount of the federal estate tax exemption allowance?

A.The 2010 Tax Relief Act establishes $5 million dollar estate tax exemption allowance for someone who dies in the years 2010, 2011 or 2013.

Unless Congress passes new estate tax laws before January 1, 2013, the estate tax exemption allowance revert to $1 million.

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Q. Is your estate subject to the federal estate tax?

A. If the value of your assets exceeds the personal estate tax exemption allowance, your estate representative will be required to file a federal estate tax return and pay taxes on that part of your estate that exceeds your allowed personal tax exemption allowance.

Q. Do states have an estate tax?

A. Prior to the 2001 estate tax legislation, states received a portion of the federal estate taxes paid.  This provision was phased out by 2005 and, as a result, many states have or are considering imposing estate taxes on the estate of the deceased.

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Q.  How do you calculate the value of the estate for estate tax purposes?

A. All of your assets are subject to the federal estate tax calculation.  Assets include real estate, bank accounts, cash, motor vehicles, stocks, dons and other securities, jewelry, fine arts or furniture, notes receivable, stock options, deferred compensation, IRAs, Keoghs, retirement plans, pensions, 401(k) plans, life insurance proceeds and all interested in businesses and business property including shares in partnerships, joint ventures, farms, right to royalties, value of intellectual property, etc.

The gross value of your estate also includes the value of any gifts given away within two years of your death that exceeded the annual gift tax allowance, currently $13,000 per person.

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Q. How do you calculate the taxable value of your federal estate tax?

A.The estate representative must make a list of property owned by the decedent and, perhaps with the help of an appraiser, assign a fair market value to the property.

The fair market value is the amount the property is worth at the time the decedent  dies (or six months later if the value is lower than at date of death), not the price the decedent paid for it.   Then, he or she must make a list of all the debts the decedent owed at your death.

If property is owned jointly with someone else, multiply the decedent’s ownership share times the fair market value to calculate the estate tax value of the property.

The taxable value of the estate is calculated by deducting the total amount of the  debts from the total fair market value of all the assets.

If the taxable value of the property exceeds the personal estate tax exemption allowance, the estate representative must file a Form 706 Estate tax return and pay the appropriate tax due within nine months of death.

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Q. How do you calculate the amount of estate tax due?

A. The amount of tax due is calculated by multiplying the estate tax rate applicable the year of death by the value of the decedent’s net taxable estate  The maximum estate tax rate for the years 2010, 2011 and 2012 is  355%.

The estate tax is a progressive tax levied on the value of the taxable estate exceeding the allowable personal tax exemption allowance, as follows:

Taxable estate exceeding personal tax exemption allowance Tax Rate
Up to $10,000 18% of excess over $10,000
$10,000 to $20,000 $1,800 plus 20% over $10,000
$20,000 to $40,000 $3,800 plus 22% over $20,000
$40,000 to $60,000 $8,200 plus 24% over $40,000
$60,000 to $80,000 $13,000 plus 26% over $60,000
$80,000 to $100,000 $18,200 plus 28% over $80,000
$100,000 to $150,000 $23,800 plus 30% over $100,000
$150,000 to $250,000 $38,800 plus 32% over $150,000
$250,000 to $500,000 $70,800 plus 34% over $250,000
$750,000 to $1,000,000 $155,800 plus 37% over $500,000
$1,000,000 to $1,250,000 $248,300 plus 39% over $750,000
$1,250,000 to $1,500,000 $345,800 plus 41% over $1,000,000
$1,500,000 to $2,000,000 $448,300 plus 43% over $1,500,000
$2,000,000 to $3,000,000 *$780,800 plus 49% over $2,000,000
Over $3,000,000 *$1,290,800 plus 55% over $3,000,000

These are the published tax rates.   However, Congress changed the highest estate tax rates for U.S. Citizens in 2010.  Currently, the highest tax rate is 35%.    The tax rates for estates in excess of $5 million would be 35%.

For example, assume the value of the estate subject to estate taxes is $5 million for someone who died in 2010.  The amount of taxes due is $780,000 plus 4% of the value over $2 million.

Q. Who will pay the estate tax?

A. The estate of the decedent is responsible for paying any estate taxes due.  The decedent can leave instructions on what assets should be used to ay the tax.   If not, the estate representative will decide how best to pay the taxes due.

When thinking about who gets what, consider the impact federal estate taxes and state inheritance taxes will have on your estate, and how estate taxes change the value of the bequests.

Q. Do states have an inheritance tax?

A. Some states have an inheritance tax, a tax imposed on beneficiaries who inherit property.  If your beneficiaries live in one of these states, they must report the amount of their inheritance as income when they file their state tax return.

You have the right to provide in your will or your trust that any inheritance taxes will be paid from the estate before the estate is distributed to beneficiaries.

Many spouses do not collect inheritance taxes from spouses or children.

Q.  Do states have an estate tax?

A Prior to the 2001 estate tax legislation, states received a portion of the federal estate taxes paid.   This provision was phased out by 2005 and, as a result, many states have or are considering imposing estate taxes on the estate of the deceased.   Like the federal estate tax, state estate taxes are paid for by the decedent’s assets.

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Q. What is the Deceased Spouse Unclaimed Exclusion Amount (DSUEA)?

A. Before the 2010 Tax Relief Act created the DSUEA form, the only way a married couple could preserve the estate tax exemption allowance of the first spouse to die was to spend time and money in setting up an A/B trust.

The surviving spouse of someone who dies in the year 2011 or 2012 can now just file  Form 706 with the Internal Revenue Service and claim the right to the  deceased spouse unclaimed exclusion amount.   When the surviving spouse dies, his or her estate representative can combine the last spouse to die $5 million personal estate tax exemption allowance with the first spouse to die deceased spouse unused exclusion amount.

The ability to transfer the estate tax exemption to the surviving spouse is sometimes referred to as portability.  The net effect is it gives married couples the right to exclude $10M of assets from federal estate taxes.

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Q. Are the proceeds from life insurance part of your taxable estate?

A. If you are the owner of the policy, or can designate beneficiaries, life insurance proceeds are considered part of your taxable estate.   Owning a sizable life insurance policy can trigger or greatly increase federal estate taxes.

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Q. How can you use gift tax rules to minimize the value of your taxable estate?

A. Gift taxes allow you to give a way a certain amount of each money tax-free.   The gift tax law are comprised of three sets of tax giving rules:  the annual gift tax exclusion, direct gifts for education and medical expenses, and the $1 million tax-free gift allowance.

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