Reducing Estate Tax - Gifts
The idea of giving away your property and money before your death and not in a will is often appealing to many in the United States. Not only does it make you feel good to take care of your family and loved ones while you are alive, but you may also be able to avoid or reduce your estate tax when you die.
As of 2009, a person in the United States can make an unlimited number of gifts of up to $13,000 per person per year. These gifts are completely tax-free and the individual that you give the gift to does not need provide you with any sort of compensation for the gift.
Any gift over $13,000 will have a gift tax imposed on it, however. Keep in mind that if your estate is large enough to invoke the estate tax, any gifts you left through your will could be reduced by as much as 55% in order to cover the estate tax. Thus, it's probably better to distribute the gifts while you're alive rather than in your will.
The estate tax has been repealed for the year 2010, but it is supposed to be reinstated in the year 2011.
Reducing Estate Tax -- Annual Gift Exclusion
The tax code of the United States contains a tax exemption rule that is called the annual gift exclusion. While some sections of the tax code can be confusing and circular, the annual gift exclusion is blessedly straightforward. Each year, you may give up to $13,000 in gifts to an individual free from taxes. As an example, if you gave your son $17,000 in cash in 2009, $13,000 of that gift would be excluded from the gift tax. However, $4,000 would be taxed under the gift tax laws.
As the years go by and inflation goes up, you should expect to continue to see the exclusion amount grow.
Reducing Estate Tax -- Doubling Your Gift Exclusion
If you are married, you and your spouse, as a couple, get to double your annual gift tax exclusion amount. So, if you were married in 2009, you and your spouse could give, jointly, up to $26,000 per person per year free from the federal gift tax. In fact, according to the Internal Revenue Code, even if a wife or a husband gives a gift without the consent of their spouse, the gift is still assumed to be made by both spouses jointly, meaning the limit is still $26,000.
Let's look at an example to make this clearer. Suppose that Henry and Wilma are well into their retirement and are looking to help their one grandchild buy a house with his wife. Henry and Wilma can take advantage of the tax code and give their grandson $26,000 and give his wife $26,000, for a total of $52,000, tax free!
Reducing Estate Tax -- Gifts to Spouses
If you are married, and your spouse is a citizen of the United States, there is no limit on the value of the gift that you may give your spouse. Any gift to a citizen spouse is tax free according to the tax laws of the United States. However, if your spouse is not a citizen of the United States, the Internal Revenue Code places a $133,000 (as of 2009) limit on the size of a tax free gift that can be given to a spouse. Therefore, if your spouse is not a US citizen, and you give him or her a $200,000 gift, only $133,000 of that gift is tax free while the remaining $67,000 is taxed under the gift tax laws.
Reducing Estate Tax -- Timing
It is worth keeping in mind the timing of your gifts as it can make a big difference in how quickly you can reduce the size of your estate. The annual gift exemption is based off of the calendar year, meaning that you cannot retroactively date a gift even if you meant to give it the year before. However, there are ways that the timing rules can work to your advantage as well. If your son needs $25,000 to pay a downpayment on his new home, you can give $13,000 in December and the remaining $12,000 in January. Because the gifts took place in separate calendar years, there will be no gift tax imposed. However, if you had given the $25,000 in December as a lump gift, $12,000 of that gift would be subject to the gift taxes.
Reducing Estate Tax -- Gifts of Non-Cash Property
The annual gift tax exemption rules apply not only to cash but to stocks, bonds and other pieces of physical personal and real property as well. For example, if you and your wife elect to give your entire stock portfolio (worth $40,000) to your friend, you may give $26,000 worth of stocks and bonds the first year and the remaining $14,000 the following year without triggering the gift tax.
Suppose that Frank and Jill have been married for 40 years and want to give their new, luxury car to their grandson for graduating from college. The car was paid in full and is held jointly between Frank and Jill and has a fair market value of $50,000. Instead of cutting the car in half, Frank and Jill can transfer the car in joint ownership to Jill and their grandson. In this way, Frank is giving his grandson his $25,000 interest in the car, which is under the annual gift tax limit. In the following year, Jill can transfer the car to their grandson outright, giving him her $25,000 interest in the car. By giving the car in such a way, Frank and Jill will avoid any gift taxes.
Reducing Estate Tax -- Gifts to Minor Children
If you plan on giving a gift of a substantial amount of money or property to a minor child, this raises an important question of management. Minor children - children under the age of 18 - cannot realistically be expected to manage a large sum of money. Most of the time, you will want an adult to manage the money until the child is old enough to take over the responsibility.
In general, there are two methods that you can use to give a gift to minor children:
- Set up an irrevocable trust for the child, or
- Set up a custodianship as long as it is authorized under state law.
In order for a gift to a minor child to qualify under the annual gift tax exclusion, the gift must meet these two conditions:
- First, for the gift to qualify, the minor child must receive an outright property ownership right by the age of 21. If you set up a trust for the gift while the child is a minor, the trust document must state that the property within the trust will be given to the gift recipient when he or she turns 21. In addition, if a custodianship is created instead of a trust, the custodianship must end when the recipient turns 21. This is not to say that the custodian of the property cannot spend the money for the child's benefit before he or she turns 21, only that the property must become solely the property of the recipient when he or she turns 21.
- Second, if the recipient happens to die before the age of 21, any remaining property from the gift must go into the recipient's estate or to someone that the recipient named, such as in a will.
Use Caution When Giving Gifts
Although you may feel that you need to lower the value of your estate before you die, you should always plan out your gifts thoughtfully and carefully. If, for example, giving away so much property and money will leave you without enough money to take care of yourself, then you should probably give away less.
You may want to sit down with a financial planner in order to figure out a plan for gift-giving. If you have a stable source of income that you can live and care for yourself with, and are still sitting on a large estate, then it may make sense to reduce the size of your estate through gift-giving before your death.