Estate planning is the process of transferring wealth to subsequent generations. Techniques involve planning for transfers at death and during life. One such mechanism is the gift, or the right to transfer assets to another person while the donor is still alive, with the goal of reducing one's taxable estate. In certain instances when all available exemptions, exclusions, and thresholds have been met, these transfers are subject to a gift tax.
- Estate planning is the process of transferring wealth to subsequent generations.
- A gift is a method of estate planning that helps reduce a person's taxable estate.
- Gifts must be given voluntarily by a donor who is competent to do so.
- These transfers may be subject to a gift tax after all available exemptions, exclusions, and thresholds are met.
- Gift taxes are assessed on the fair market value of the gift on the date it is transferred to the recipient.
What Is a Gift?
A gift occurs when a voluntary transfer for less than full consideration or compensation occurs from a donor to a donee. A valid gift must satisfy the following criteria:
- The donor intends to make the voluntary transfer.
- The donor is competent to do so.
- The donee is able to receive the gift and has to take delivery.
- The donor cedes all control over the property given.
Types of gifts include:
- Direct: The donor transfers cash or property directly to the donee.
- Indirect: The donor makes a transfer for the donee's benefit. Somebody pays their significant other's credit card balance, as an example.
- Complete: In making a transfer to the donee, the donor gives up all rights and dominion over the property.
- Incomplete: In making a transfer to the donee, the donor fails to give up all control over the property. If somebody places money into a revocable trust, then they have made an incomplete gift as they retain the right to control the ultimate disposition of what is in the trust. By contrast, should the trust become irrevocable, then its contents constitute a completed gift.
- Reversionary Interest: Gifts that the donor transfers to the donee which revert back to the donor. Their worth to the donee is their present value rather than fair market value (FMV). An example would be when a donor places money in a trust for a specific time period for the donee's benefit. At the end of the term, the money or property reverts back to the donor. The value of the gift is less than the value of the property in this instance.
- Net Gift: Whereas in most instances the donor is responsible for any gift tax, in the case of a net gift, the donee would be.
For gift tax purposes, the value of the gift is its FMV on the date of its transfer to the donee. Real estate and collectibles would require an appraisal. A bond would be valued as the present value of its future payments. The value of publicly traded shares would be the average of the high and low share prices for the day on which they are gifted.
An opinion of a qualified valuation specialist would be required for privately held shares (e.g., private equity), taking into consideration potential restrictions on marketability, control, and liquidity.
The U.S. Treasury has guidelines for certain types of property. Gifting appreciated assets would make more sense to the donor as they would remove a larger sum from their estate. One needs to consider the totality of one's tax planning needs and consult a professional.
Once one has determined a transfer to be a gift, the next step is to determine at what point the gift tax will apply to that transfer.
Types of Exemptive Relief
The Annual Exclusion
Gifts up to a certain value per donee per year are subject to the annual exclusion. The amount is $15,000 for the 2021 tax year and $16,000 for 2022. Spouses may both give gifts to the same person, doubling the gift: This means that each may give the $15,000 ($16,000 for 2022) amount or $30,000 ($32,000 for 2022).
The gift must be of a present, rather than future interest. This means that the recipient is not subject to any restrictions on the right to use the property immediately. Gifts of a future interest, which allow the recipient unfettered access only at a later date, are not eligible for the annual exclusion and are fully taxable.
Exceptions are UTMA/UGMA accounts where money is held in trust for minors who are the beneficial owners of the account and the trustee who is the nominal owner may distribute proceeds for the minor's benefit. This is known as the Crummey provision, which gives a trustee powers of appointment to withdraw money at a future date and gifts to minors in trust ((2503(b) or 2503(c)).
The Applicable Unified Credit Amount
The Tax Cuts and Jobs Act (TCJA) made changes to the lifetime gift and estate tax credit amounts that can be sheltered by individuals. The Internal Revenue Service (IRS) allows a maximum of $11.7 million in 2021 to be sheltered before taxes kick in. That amount increases to $12.06 million in 2022. This means that individuals can leave up to these amounts for these tax years and pay no federal estate tax.
Transfers Not Subject to Gift Tax
Certain types of gifts are exempt from gift tax.
- Qualified Transfers: Payments made directly to a qualified academic institution or medical care provider on behalf of the donee escape any gift tax.
- Payments for Support: Legal obligations for children or other dependents may be exempt from gift tax. An example would be payments for higher education and room and board.
- Payments Pursuant to a Divorce Settlement: Alimony is not a gift, but rather taxable income to the recipient (payee) and a tax-deductible contribution to the payer. Property transfers within a year of a marriage's termination and related to that termination are deemed pursuant to a divorce decree and not a gift.
- Transfers to Political Organizations: Exempt, too, from gift tax are gifts made to political organizations. These are broadly defined as those advocating the selection, nomination, or appointment of any individual to federal, state, or local public office.
- Business Transfers: Transfers in a business setting are typically deemed compensation. De minimis gifts such as those to reward years of service or commemorate one's retirement are not subject to the gift tax.
- Spousal Gifts: Transfers between spouses are exempt from gift tax so long as the donee spouse is a U.S. citizen. If the donee spouse is not a citizen, there is a limit on the tax-exempt transfer.
- Charitable Gifts: Gift tax charitable deductions are unlimited so long as the recipient is a federal, state, or local government for public use, a 501(c)(3) corporation for educational, religious, charitable, or scientific purposes; or a 501(c) fraternal or veterans organization.
The Bottom Line
One must file a gift tax return (IRS Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return) if one gives gifts that exceed the annual exclusion, are of a future interest, or exceed the unified credit amount.
When determining whether or not one owes gift tax, one needs to determine what gifts were given for the year, whether or not they are exempt from gift tax or within the annual exclusion amount, and to what extent they may be offset by the unified credit amount for the year in question. Above all, one should consult a tax professional when undertaking any tax planning decisions.