For most U.S. citizens the answer to the question, “How much is the gift tax?” can be “not one red cent” with proper planning.
Under current tax law, if a person accumulates enough assets, an estate tax can be imposed upon death. The estate tax becomes an issue once the taxable estate reaches a threshold amount that increases with inflation each year. In 2017, that threshold is $5,490,000 per person or, with good planning, $10,980,000 per couple. The estate tax is imposed based on what is owned and transferred at death to heirs. The tax can be as high as 40%.
The gift tax uses the same scale as the estate tax but applies to transfers made while one is alive. It is generally charged to the donor, not the recipient.
Because the estate tax rate is so high, someone near the end of their life has a strong incentive to give their assets away so their heirs can claim the assets were not part of the estate and avoid the tax. By imposing a tax on gifts, the ability to make “deathbed” transfers to avoid the estate tax is reduced.
What Is a Gift?
What is and isn’t a gift seems like a straightforward issue, but from a tax code perspective, there are some nuances worth noting.
First, the transfer of an asset to another generally must be a full and actual transfer of ownership. The term in the tax code is a “completed gift.” The transfer cannot be contingent upon an event or action and the donor cannot have the ability to get the asset back. (For related reading, see: What Are Gift Taxes?)
There are gifting techniques that allow funds to be used for the donor’s benefit. For instance, a gift can be made to a trust that pays the donor income for a specified time period, after which the assets shift to a beneficiary. (This technique can be complex and beyond the scope of this primer, but we wanted to acknowledge not all gifting involves the immediate and full surrender of an asset.)
Second, the value of the gift is typically the fair market value of the asset when the gift is completed, not what the donor wants to claim the asset is worth. Since the taxes are based on the value, donors have an incentive to claim assets are worth less than they really are. For gifts of cash or assets like publicly traded securities, valuing the gift is straightforward while other assets, such as real estate, art and jewelry, can be more challenging.
Many lifetime transfers are exempt from gift taxes. Just as you can leave an unlimited amount to your spouse or qualified charities upon your death without estate taxes, you may give unlimited amounts to your spouse or to a qualified charity anytime during your life without gift taxes.
For gifts to other recipients, there is an “annual gift tax exclusion.” It was $10,000 for many years but in 2017 became $14,000. (This limit is indexed to inflation and should be modestly higher at some point in the future.) The exclusion permits you to gift up to $14,000 of assets each to as many people as you like during 2017.
Your spouse is also able to gift to you an unlimited amount and $14,000 to as many people as desired. Therefore, between the two of you, up to $28,000 can be gifted without incurring any gift tax. Keep in mind the gifting limit is per person per year. So, suppose you wish to give a gift to your son who is married. Both you and your spouse can gift $14,000 each to your son and his spouse for a total of $56,000 in gifts for 2017 with no gift taxes.
To avoid gift taxes on gifts that exceed the $14,000 exclusion, you may need to file a Form 709 depending on the amount and titling of the account from which the gift is made. This is a special tax form that is not found in the typical 1040 tax packet. (For related reading, see: How Do You File IRS Form 709?)
Cash Gifts to 529 Plans
What you want this money to be used for can offer more exemptions and special rules. You can use up to your next five years’ annual exclusion in advance by making a cash gift of $70,000 (five times $14,000) to a section 529 college savings plan without incurring gift taxes. Got four grandchildren? Then $280,000 can be gifted at one time free from tax. (If additional gifts are made within five years, a Form 709 may be needed to avoid gift tax.)
A cash gift paid directly to a university for tuition on behalf of a student or paid directly to an institution for certain health care expenses are not subject to the annual limit and do not count toward the limit.
What if a married couple wanted to give $100,000 to their son and his spouse?
Because the exclusion is available annually, if the need for the $100,000 is not urgent, they could simply make the gifts over two tax years. We often see this done in the fall. Our couple could give the $56,000 in the fall and the rest in January.
Another Way to Avoid the Gift Tax
Even if the annual limit is exceeded, gift taxes may still be avoided. Say a single man wants to give his only child $100,000. There is only one $14,000 annual exclusion amount available. By filing Form 709 and using some of his unified credit, no taxes are payable. All U.S. citizens get a credit against estate and gift taxes for the tax on estates equal to the exemption amount ($5,490,000 in 2017).
He can give his son $100,000 which is $86,000 over the limit, file a Form 709, uses some of his credit, and avoids gift taxes. The ramification is that he can no longer leave $5,490,000 free of estate taxes. If he dies in 2017, he will only be able to leave $5,404,000 ($5,490,000 less $86,000) estate tax free.
Despite the complexity of our tax code, basic gifting goals can usually be satisfied with simple techniques and the right paperwork.
(For more from this author, see: The Overlooked Benefits of Roth Accounts.)
Adapted from an article that originally appeared at moisandfitzgerald.com.