By: Beatrice Wolper, Kelly Jasin, and Heidi Kemp
As we approach the end of another year, families are gearing up for the busy holiday season. With all the holiday parties, school events, decorating, and shopping, it’s not unusual to forget about your finances or any legal matters. However, the end of the year is always an excellent time to analyze your gifting situation.
There are four types of taxes: income tax, gift tax, generation skipping transfer tax, and estate tax. The 2018 estate tax exemption is over $11 million dollars per person! This means that as the law stands right now, you can give away over $11 million dollars during life and/or at death without paying any gift or estate tax. This high exemption amount provides an excellent opportunity to get assets that are likely to appreciate over time out of your estate without having any gift or estate tax consequences. That goes for assets that are producing a lot of income, such as oil and gas royalties. It’s possible to gift the royalties in a way that passes the income tax down to your children so that perhaps the overall income tax burden is less since presumably your children are in a lower tax bracket.
Many people aren’t prepared to gift actual interests in their assets but still want to make gifts to their children or grandchildren. The 2018 annual exclusion is $15,000 per person per year. This means that you can give up to $15,000 to anyone this year and you don’t even have to report it to the IRS. There’s no tax on the giver or the receiver. If you are married, that means you can gift $30,000 per person this year. Most people make these types of gifts to family members but there are no restrictions on whom you may give gifts. The recipients do not have to be family members.
There are a couple of “unlimited” exclusions that often don’t get discussed. You should always consult your tax advisor when in these situations to be sure that you are complying with the IRS rules. However, generally, if you pay tuition directly or pay for medical bills directly for someone else, those amounts are not included in the $15,000 annual exclusion. These unlimited exclusions allow you to pass on much more than the $15,000 per person per year limitation if done correctly.
So, what if you gift your child $50,000 in one year? There’s still no gift tax on the giver or the receiver. But, since it is over the $15,000 annual exclusion, you must notify the IRS that you have made a gift. This is done through a Form 709 gift tax return that is filed with the IRS along with your personal income tax return. The gift tax return in this case is an informational return to notify the IRS that you have used up $35,000 of your approximately $11 million dollar exemption. This is how the IRS tracks how much you have gifted during your life to know how much you are able to pass at death without estate taxes. The $35,000 is because you gave $50,000 but you may subtract the $15,000 for the annual exclusion. Please remember that the annual exclusion includes ALL gifts made in that year. So, if you buy your children birthday and Christmas presents, those need to be taken into consideration when determining how much of the annual exclusion amount you have left.
So far, we’ve been talking mostly about cash. Annul exclusion gifting may include gifts of family businesses. Many people who are in the process of transitioning ownership of a family business to the next generation develop annual gifting plans to slowly transfer portions of ownership. This process works very well but is somewhat complicated because you have to determine the value of the interest in the family business that is being gifted. However, an experienced estate planning attorney and tax advisor can help you with this process.
