Tax Planning Tutorial: This Fee Only Planner Thinks It’s Time To Clear up the Confusion Over the Gift Tax Law

Here's the low-down on the gift tax law:TAX PLANNING 101

There are many confusing tax laws, but the one that seems to generate the most misunderstanding is the gift tax law.

Many are aware that gifts can be made up to $14,000 in 2017, (this amount is periodically adjusted for inflation) with no tax consequences – but beyond that it’s fuzzy. A client asked me today if she would have to pay tax on a $100,000 gift her parents were planning to give her to buy a house. The answer is no.

Here’s the low-down on the gift tax law:

1. Anyone can make gifts of up to $14,000 (in 2017) to as many people as they choose without any tax implications. This gift is called an “annual exclusion gift”- meaning the gift is tax-free for the giver and the receiver. In each following year,  the donor can start all over again giving gifts up to the annual exclusion amount to as many people as they choose. The gift can be either cash or goods.

2. If a donor exceeds the annual exclusion ($14,000 in 2017) to any one person, the tax is still not due unless the gifts go over the generous lifetime estate and gift tax exemption of $5.49 million per person.  A minor annoyance:  Form 709 – United States Gift Tax Return – must be filed with that year’s tax return. But NO tax is due.

3. The recipient of said gifts whether it be $14,000, $100,000 or $500,000 does not pay tax on the money ever, at all.

Let’s step back and define what a gift is for IRS purposes:  It’s something that is given and nothing is received in return. It is complete as a gift. Loans are not gifts.

What  are some of the reasons people give gifts?

  1. They are generous and kind.
  2. They want to help a loved one with expenses such as a down payment on a house,
    education costs, or a vacation.
  3. They are very wealthy and want to reduce the size of their estate and therefore, estate taxes.
  4. They know they won’t spend all their money during their lifetime and want to
    share it with their loved ones before they die.

Examples:

1. You and you spouse decide to give $14,000 each to your four grown children for Christmas. The total gift amount is $112,000. No tax is due and no gift return is filed.

2. The Brown’s gives $200,000 to their daughter Sally, to assist in her purchase of her first home. A gift tax return (Form 709)  for $172,000 ($200,000 –  $14,000 x 2) would be filed with that year’s tax return.  In subsequent years, any gifts the Browns’ give over the exclusion amount will be added to the $172,000. In 2017, the estate and gift tax exemption per individual is $5.49 million per individual.

How the estate and gift tax are tied together:

Let’s say the Brown’s, over their lifetime, gift $1,000,000 in gifts over the annual exclusion amount. When they die, the $1,000,000 will be subtracted from their lifetime estate and gift tax exemption – $5.49 x 2 =  $10.98 million – $1 million  = $9.98 million or $4.99 million each.

It’s obvious that very few but the most wealthy will exceed the estate and gift tax exemption, and in consequence few people pay estate or gift tax. This wasn’t always so. The basic exclusion amount (or applicable exclusion amount in years prior to 2011)  was $1,500,000 (2004-2005), $2,000,000 (2006-2008), $3,500,000 (2009), $5,000,000 (2010-2011), $5,120,000 (2012), $5,250,000 (2013), $5,340,000 (2014), $5,430,000 (2015), $5,450,000 (2016), and $5,490,000 (2017).

Spousal gifts and portability

Spouses fall under different rules when it comes to gifting and estate or gift tax. The unlimited marital deduction allows you to gift any amount of money or property to your spouse without incurring either the federal gift tax or a state gift tax if you live in a state that imposes one.

In addition, in 2013, Congress passed the American Tax Relief Act of 2012 (“ATRA”). One of the key provisions of ATRA is to make permanent the portability of the applicable exclusion amount between spouses, which was enacted by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Portability allows the first spouse to die to transfer his/her unused estate tax applicable exclusion amount to the surviving spouse, who can then use it for his/her gift or estate tax purposes. The key is to be sure to file an estate tax return at the first spouse’s death to elect portability.

Gifts made directly for education or medical expenses qualify for exclusion.

Payments that you make on someone’s behalf for qualified tuition or medical expenses do not count towards the annual limit for gift tax purposes.

However, your payment(s) must be made directly to a qualifying educational organization or medical care provider in order to qualify for the exclusion. You can also place funds directly into a 529 education savings plan to avoid the gift tax.

Trump Administration Proposal

The Trump administration is proposing to eliminate the estate tax altogether and instead impose a 20% capital gains tax on assets left to heirs above a $10 million threshold. I guess for the very rich 20% trumps 40% any day.

What this means for someone who’s amassed a sizable amount of wealth is that even though their heirs would no longer be subject to estate tax, they’d still inherit assets with a built-in tax liability. They could avoid the capital gains tax if they decide to hang on to the assets in question.  If they opt to sell assets that have appreciated substantially, they’re going to feel the tax bite at some point.

Do you want to manage your money (and life!) better?

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