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 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.
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, to wit:
- 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 right 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. 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 fair market value 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 price 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. For certain property types, the United States Treasury has issued guidelines. 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.
When Does the Gift Tax Apply?
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 an annual exclusion. Starting in 2018, the amount is $15,000. Spouses may both give gifts to the same person, doubling the gift: This means that each may give the $15,000 amount or $30,000.
For it to be available, 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 would be 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 ; a Crummey provision giving 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
There is a lifetime of unified gift and estate tax credit amounts which may be used to shelter up to $11.18 million in taxable transfers, due to changes passed by the Tax Cuts and Jobs Act . In 2019, that figure will rise to $11.4 million.
This means that individuals can leave up to that amount 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 payor. Property transfers within a year of a marriage's termination and related to that termination is 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 veteran 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.