Gifting money can be a very effective way to transfer substantial amounts from your estate, free from gift and estate taxes, to your children or other loved ones. This technique of estate tax planning can drastically reduce your taxable estate after your death, and could thereby reduce your associated estate taxes.
The Federal Government levies taxes on what they call “gratuitous transfers of assets.” These are financial gifts in the form of money, stocks, bonds, property, or anything else you wish to give. The gift tax can eat away your at your estate. In 2017, you can give up to $5.49 million without gift tax. After that, 40 percent of each dollar gifted goes in tax.
Luckily, there are certain exceptions to the gift tax as outlined in Section 2503(b) of the IRS tax code. One such exception is the annual gift tax exclusion. This is an amount that can be given away annually without resulting in gift tax on the transfer. As easy as this may sound, there are certain criteria you have to meet in order for your gift to qualify as an exclusion, and there are even exceptions to the exception!
Let’s take a look at the Annual Gift Tax Exclusion as well as some exceptions to the rule.
Give a Gift of $14,000
In the year 2017, the annual gift tax exclusion amount is $14,000 per recipient. There is no limit on the number of recipients to which qualifying gifts can be made. The key word here is qualifying. That’s right! Not every gift will qualify for the annual gift tax exclusion.
The IRS does not consider a gift to be qualified unless the person receiving the gift possesses a “present interest,” an immediate ownership, in the asset. This means that, in general, transfers in Trust are not considered present interests, but future interests.
The unlimited marital deduction is an entirely different kind of gifting that allows spouses to leave their property to the surviving spouse without incurring any gift taxes. This is not true, however, if the surviving spouse is not a U.S. citizen. In this case, the annual gift tax exclusion kicks in, but has a much higher value of $149,000.
Gift-Splitting By Married Taxpayers
If the donor of the gift is married, gifts made during a year can be treated as a “split” between the husband and wife, even if the cash or gift property is actually given by only one of them. By gift-splitting, therefore, up to $28,000 a year can be transferred to each recipient by a married couple because their two annual exclusions are available.
Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return(s) the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Since more than $14,000 is being transferred by a spouse, a gift tax return will have to be filed, even if the $28,000 exclusion covers the gifts. So, be aware that if you elect gift-splitting, you’ll need to file Form 709.
Giving to Minors
Oftentimes, when you choose to gift to a minor, you want to delay access to the gift but still receive the annual gift tax exclusion. Although typically, you have to give a present interest, there are approved vehicles for providing future interest. One such vehicle is the “Section 2503(c) Trust for Minors.”
In order for a gift to qualify under this Trust:
- The money and interest in the Trust can be spent on the minor by the Trustee before the minor reaches the age of 21
- Any assets not spent by the time the minor turns 21 must be turned over to the minor
- If the minor dies before the age of 21, the assets in Trust must become part of the minor’s estate.
Another gifting strategy for minors is to establish a custodial account under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA). Using this strategy, assets are placed in a custodian’s name for the benefit of a minor. This custodianship ends when the child reaches adulthood, at which time the custodian must give all the property to the child. Once again, if the minor dies before reaching adulthood, the assets will be placed in the child’s estate.
Another method is using a standard Irrevocable Trust, like a Life Insurance Trust, and give the beneficiary the right to withdraw the money for a period of 30 days. This “Crummey” power, named after the case approving its use, converts the future interest into a present interest.
Even with these different gifting strategies for minors, you are still only able to gift $14,000 per year per recipient. You can arrange for larger gifts by providing monies used for tuition, health care, and charities.
Do you have a child or grandchild in college? A favorite niece or Godchild in private school? There is a way to gift to these individuals without worrying about the annual gift tax exclusion limit. Simply pay their tuition.
The government provides an exclusion from the gift tax for gifts made to pay tuition to a college, university, private high school, private grade school, and even some private nursery schools. It is permitted for both full-time and part-time students. However, there are specific rules to follow:
- The money must be paid directly to the educational institution. If you make the check out to anyone else, even if it is to repay tuition, the gift will not be excluded from taxation.
- Room and board, books, or supplies do not qualify as part of tuition.
- The IRS must recognize the educational organization as qualifying. To qualify, a school must have a regular faculty, a curriculum, and a regular body of pupils there to be given formal instruction. Most elementary schools through universities qualify easily. Be careful before making this deduction on a daycare or nursery. Only a few are likely to qualify as providing formal instruction.
Medical Expense Gifts
Like paying tuition, paying someone’s medical care expenses are also exempt from the $14,000 per year per recipient limit. Medical expenses would include any type of medical expense deductible for income tax purposes, including payment of insurance premiums. Eligible medical care expenses include amounts paid for:
- Diagnosis, cure, mitigation, treatment or prevention of disease.
- Transportation primarily for and essential to medical care.
- Qualified long-term care services.
- Insurance covering medical care or long-term care.
- Certain lodging away from home for medical purposes.
Again, the payment must be made directly to the provider and it cannot be reimbursed by insurance.
Section 529 Plans
You may also consider contributing to a qualified prepaid tuition program for your children or grandchildren (IRC 529 Plan). Although contributions are subject to the $14,000 annual exclusion, you can pre-fund a child’s or grandchild’s 529 tuition plan with a $70,000 contribution in one year, if you make no further gifts to that child or grandchild in the next four years. The $70,000 gift is spread over the next five years for the gift tax purposes, but the entire $70,000 can start earning interest immediately.
If you are charitably inclined, there are many tax advantages to making a gift to a favorite charity. You can make outright gifts of cash, appreciated assets such as securities, life insurance, or even real estate. Many educational and charitable organizations also offer plans that combine the benefits of an immediate income tax deduction and payment to you of lifetime income from the charitable gift. Gifts to charities are generally tax-exempt, but it is best to check with the IRS to be sure that the charity qualifies.
Gifting fulfills a personal desire to contribute to a worthy cause, helps a loved one in need, and uses strategy in planning one’s estate. Before implementing any significant tax or financial planning strategy, however, contact an attorney whose practice is focused on estate planning. If gifting is not structured properly, it may cost you more than you realize.