I encounter many people who don’t understand the rules of the gift tax and even more who have never even heard of a gift tax. Here are the basics of the gift tax so that you can be aware of the issue, and always consult your estate planning attorney BEFORE making a gift!
The Gift Tax
Current tax law allows (1) an annual gift tax exemption and (2) a lifetime unified exemption for federal estate and gift taxes. Transfers to individuals (who are not your spouse) during your life can be subject to the federal gift tax and reporting those gifts on a gift tax return.
Annual Gift Tax Exemption
Any gifts to individuals have an annual exemption which can apply to reduce the amount of the gift. The current annual exemption is $15,000 per person, per year. Thus, any one person can give $15,000 to every person on the planet each year without being subject to the gift tax (This amount is adjusted for inflation and the annual exclusion amount may change in future years.).
However, if a gift to an individual exceeds this $15,000 annual exemption, the Donor needs to file a Federal Gift Tax Return to report the value of the gift to the IRS.
For example, if Bill gives his adult daughter Claudia $50,000 in one year, Bill must file a Federal Gift Tax Return. Bill is allowed to subtract his $15,000 annual exclusion from the $50,000 gift, leaving a taxable gift of $35,000. Then, Bill is able to use his lifetime unified exemption (currently $11.7 million dollars, however, this amount may be changing soon) to cover the tax on the remainder of the gift. Even though no tax is due on the gift, the Federal Gift Tax Return is required to be filed.
Medical and Tuition Exemptions
Think: No Dollar Limit. I always refer to these exemptions as “the name on the check” exemptions for medical bills and educational gifts. No dollar limitation applies to a donor who makes gifts for another individual’s medical bills or tuition bills provided that the payment is made directly to the medical provider (i.e. the doctor or hospital) or educational institution. For example, if Bill’s adult granddaughter goes to Yale University, and Yale’s tuition is $75,000 per year, Bill can write a check to Yale University in the amount of $75,000 on his granddaughter’s behalf, and that gift is not subject to the gift tax.
Another great trick is for 529 Plans to help individuals pay for higher education. Donors can front load a 529 Plan with 5 years of annual exclusion gifts ($75,000.00) in one year without being subject to a gift tax. However, a gift tax return must be filed to notify the IRS of the gift.
Other Tax Consequences
One important thing to remember is if a Donor gives an asset which has appreciated in value to another individual, the Donee now has the same basis in the asset that the Donor had. For example, if Bill gives a house which Bill purchased at $100,000 to Claudia, then Claudia’s basis in the house is $100,000. If Claudia sells the house the next day for $300,000, Claudia reports $200,000 of capital gain.
Sometimes, it is worth holding on to an appreciated asset until death to give the Donee a step-up in basis to fair market value as of the Donor’s date of death. For example, if Bill had kept that house, and if, on Bill’s death, the house was worth $300,000, if Bill left the house to Claudia in his Will, Claudia would get a “step-up” in basis to $300,000 in the house. If Claudia sold the home the next day for $300,000, she would owe no capital gains tax.
Gifting Strategy
Your estate planning attorney will have the best tips for you on how to plan for gifts above the annual exclusion amount, how to properly choose assets for gifts, how to document gifts, and how to report any gifts. Therefore, before gifting, it’s best to reach out to your estate planning attorney who can assist you with a gifting strategy that minimizes potential tax consequences.
If you have questions or would like to schedule a meeting with an attorney at Loveland | Grace | Hurley, PLLC about your gifting strategy, please contact us to schedule an appointment. We offer appointments in-person as well as by phone and video conference.