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.
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.
$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.
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.
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.
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.
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.