Reducing Estate Tax - Gifts
The idea of giving away your property before your death rather than in a will is appealing. Not only does it feel good to take care of your loved ones while you're alive, doing so could also avoid or reduce your estate tax which, as of 2017, applied to estates valued at over $5.49 million. If the value of your estate could trigger the estate tax at your death, then waiting to make gifts through your will could actually end up reducing those gifts by as much as 55% or more.
If the estate tax could apply to you, the information below will show you how to use lifetime gifting to reduce your estate tax liability.
Annual Gift Exclusion
The U.S. tax code contains a tax exemption rule called the annual gift exclusion which is surprisingly straightforward. As of 2017, you're allowed to make an unlimited number of gifts of up to $14,000 per recipient per year. These gifts are tax-free and the recipient isn't required to provide you with any compensation. Gifts exceeding $14,000 per year are subject to the gift tax. This amount can be changed by Congress, but is likely to increase with inflation in the future.
Doubling Your Gifts
If you're married, your gift tax exclusion amount doubles as you can each give up to $14,000 per recipient per year. So, if you were married in 2017, you and your spouse could jointly give up to $28,000 per recipient per year tax free. In fact, 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.
As an example, suppose that Henry and Wilma are well into their retirement and are looking to help their granddaughter buy a house with her spouse. Under the annual gift exclusion, Henry and Wilma can give a total of $56,000 tax-free -- $28,000 to their granddaughter and $28,000 to her spouse.
If you're married and your spouse is a U.S. citizen, there's no limit on the value of gifts you can exchange together as any gift to a citizen spouse is tax free. However, if your spouse is not a U.S. citizen, there's an annual limit on how much can be gifted ($149,000 as of 2017). Any amount beyond that is subject to the gift tax.
Timing of Gifts
The timing of your gifts can make a 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 to use the timing rules to your advantage. For example, if your son needs $25,000 for a down payment on his new home, you can give $14,000 in December and the remaining $11,000 in January. Because the gifts took place in separate calendar years, even if only a few weeks apart, there will be no gift tax imposed and you will have quickly reduced your estate by $25,000.
Gifts of Non-Cash Property
The annual gift tax exemption rules also apply to stocks, bonds and other pieces of personal and real property. For example, if you and your spouse elect to give your entire stock portfolio (worth $40,000) to your friend, you may jointly give $28,000 worth of stocks and bonds the first year and the remaining $12,000 the following year without triggering the gift tax.
There are also ways to gift portions of property over time to avoid the gift tax. For example, suppose that Frank and Jill, a married couple, want to give their fully-paid luxury car to their grandson Jimmy. The car is held jointly and has a fair market value of $50,000. If the couple first transfers Frank's interest in the car to Jimmy, then this would constitute a gift of $25,000, (under their joint annual gift tax exemption of $28,000). The following year, Jill can transfer her $25,000 interest so that Jimmy owns the car outright and no gift taxes are triggered.
Gifts to Minor Children
If you plan on gifting a substantial amount of assets to a minor child, this raises questions regarding management. Most of the time, you'll want an adult to manage the money until the child is old enough to take responsibility. Generally gifts to minors are made through either an irrevocable trust, or a custodianship/guardianship.
When gifting to a minor child, either through an irrevocable trust or a custodianship, the gift must meet the following conditions to qualify under the annual gift tax exclusion:
- The minor must receive outright ownership by age 21; and
- If the minor dies before age 21, any remaining property must go into the minor's estate or, if there is a will, to the minor's beneficiary(ies).
Give, But Be Cautious
Although you may feel the need to decrease the value of your estate before you die, you should always carefully plan out any gifts. After all, you don't want to give away so much of your estate that you're no longer able to take care of yourself. However, if you're in a strong financial position to care for yourself and are sitting on a large estate, gift-giving before your death may make sense.
Free Initial Legal Evaluation of Your Gift Tax Questions
The ability to gift assets is an important tool in any tax strategy. However, before you start writing checks or dividing up property, it's critical to speak with an experienced tax attorney. After all, tax laws and gift exclusion limits can change every year. Get your questions answered today by reaching out to a qualified attorney for a free case review.