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Many high earners want to know the most tax-efficient strategies for gifting assets to the people they care about. With concerns over lower estate tax exemptions in the future, BWM Financial is helping clients pass their wealth to loved ones in a tax-efficient way during their lifetimes. Weexplain thefundamentalgiftingrules,benefits, andmethodstobeconsideredwhen creatingmeaningful and tax-advantagedlifetime gifting strategies.
What is gift tax and who pays it? What is the gift tax exclusion amount for 2021?
Gift taxis a federal taxpaidby thepersonwhomakes the giftandreceivesnothing (or less than the gift’sfullvalue) in return.This taxratemayrangefrom 18%to 40%andappliesto giftsexceedingyourannual giftexclusion,whichis acertain flat dollar amount that variesbasedon your filing status.In general, single taxpayers may gift up to $15,000 per year to any one personfree of gift taxes. For married taxpayers filing a joint tax return, thegift tax exclusiondoubles to $30,000 per year.
This means amarried couplewith two kidsmaygift$30,000 per year to eachchildwithoutgift or estate tax implications.But imagine they wanted to gifttheirson$70,000 this year to helphimbuy a home. Could they make a gift over their annual $30,00 exemption amountwithout paying taxes?Yes, the IRS saysthey canmake a tax-free giftover theirannualexemptionif they apply theirexcess gift of$40,000[$70,000 gift – $30,000 exclusion]towards their lifetime “bucket” of tax-free gifts. This is called the lifetime exemption amount.
What is my lifetimeexemption amount?
Yourlifetime exemption amount, also known as yourlifetimegiftand estate taxexclusion,is the amountof assets you can give away tax-free during your lifetime. In other words, it’s the amountof your estate that will not be subject totaxes at the end of your life.
For a singletaxpayer,the currentlifetimeexemption amount is$11.7millionin 2021. Married taxpayers have a combinedexemption amount of $23.4 million.Today’shighexemptionswere enacted by the Tax Cuts and JobsAct in 2017and providean opportunityto gift away a substantial amount of wealthtax-free. Butthis window of opportunity islimited.In 2026,thelifetime exemptionis scheduled torevertto$5.49 millionper individual,adjusted for inflation.However,newproposalsmay lowerthe lifetime exemption to only $3.5 million per individualpossibly effective byJanuary 1, 2022.
Thegood news is if youmoveassetsout of your taxable estatetoday,yourcurrent$11.7millionlifetime exemption amount will apply, even iftheexemptionisreducedin upcoming years.Thismeansifyouwere togift away or transfer assetstodaythat arein excess ofthe lowerfuture exemption, you will have secured the use oftoday’slarger$11.7 millionexemption.
Here is abasic example to illustrate.Supposeyou’ve nevermade a giftover your annual$15,000exemption amount, but this yearyoudecided totransfer$10milliontovariousloved onesinto trusts for their benefit.Your gift would becompletelytax-free becauseitisunder yourcurrent$11.7millionlifetime exemption.
Now imagine in 2022thecurrent $11.7 millionlifetime exemptionfor a single taxpayer isreduced to$3.5 million.Since your$10 milliongift wasconsideredtax-freeat the time it was made, your estate will not owe taxeson yourgifteven though itwaswellover thenew$3.5 millionlifetime exemption.However,keep in mind that youwill have alreadyexhausted thenew$3.5 million lifetimeexemption.This means any future gifts over your annual $15,000 exemption amount would be subject to gift and estate taxes.
Do gifts need to be reported to the IRS?
In general,single taxpayers who gift over $15,000per yearand married couples who giftover $30,000per year toa singlepersonare requiredto file a gift tax return(Form 709).Thereis anexceptionfor gifts made to your spouse. If your spouse is a U.S. citizen, the IRS says youcan gift him or heras much as you want tax-free and you do not need to file a gift tax return.These rules are different if one or both spousesarenot U.S. citizens.
Keep in mind,being required tofile a gift tax return doesn’t mean you’ll owe gift taxes.Form 709 simplyhelpsyouand the IRSkeep track of yourlifetime estate tax exemption.In general,youwillonlyowe gift taxes if you have already used up yourlargelifetime exemption.
Evenif you’re not required to file a gift tax return, in certain situations you may benefit from filing one anyways.This is especially true if you gifted assetsthat are hard to value, such asartwork or an ownership interest in your family business. Filinga gift tax returnisa way to discloseyour transferof assets. Italsostarts the clock onthe statute of limitations.Thisgenerallymakes it more difficult forthe IRS to challenge the valuation of your gift more thanthree years after you file your gift tax return.
Certainexceptions and special rules exist for calculating gift taxes. Because of this,it’s bestlet your CPA know of any meaningful gifts you made during the year. You may want to do this even forgiftsthat were under yourannual$15,000exclusion amount.
Do I have to paytaxes on gifts received?
You typically do not owe taxes for merely receiving a gift.However, you mayowetaxes if youlatersell the asset you were gifted for a gain. Your taxable gain would be the difference betweenyournewsales priceand theoriginalpurchase price paid by the person who gave you thegift.
For instance, suppose yourgrandparentsgiftedyou10sharesofstock worth$500each.They purchasedthis stock for$100per share.If you decided to sell one share at its current valueof $500,your taxable gain would be $400[$500newsales price – $100originalpurchase price].In addition, your holding period for purposes oflong or short-termcapital gainswould be calculated starting with the date your grandparentspurchasedthe stock.
For example, imaginethe stock yourgrandparentsgifted you waspurchasedby them onMay 1,2020.If you were to sellthestock onMay 1,2021,or sooner, you would owe short-term capital gains. But if you were to sell the stock on May 2,2021,or later, you would owe more favorable long-term capital gains.Remember, investments must be held for at least one year and one day to receivethelong-termcapital gains tax rate.
You mayalsoowetaxesif you receivedgiftsthat generateincome.In this case, it’s just like owning any other investment. You don’towetaxes when you receive the investment. Butif itpaysincomewhile you own it, you paythetaxes.Before filing your taxreturns, make sure your CPA knows about all your sources of income, including income received from gifted assets.
Is it possible to make larger giftswithoutreducing my lifetime exemption?
There are carve-outs for educational and medical care gifts that will not count against your lifetime exemption.TheIRS says that paymentsmadeon behalf ofanother individualthat are paiddirectly to an educational ormedicalprovider are tax-free.
For example, imagine you have a nephewwith $50,000 in medical bills froma suddenhealth problem. You and your spouse would like to cover theentirebill butare worried about payinggift taxes for the amount over your $30,000 annual exemption. Rather thangiftingyour nephew cash to cover his bill,youcan simply pay his medical provider directly without anyincurringany gift taxes.
The same rule applies forqualifiededucational costs.You maycoveranother individual’squalifiedtuition orothereducational costswithout triggering gift taxesif you paytheeducationalinstitutiondirectly.
On top ofthat,theIRSgenerallyallowsaspecialtax-free waytofrontloadfiveyearsofgiftsinto529college savings plansin a single year.This is a way togiftmultiple years’ worth of the$15,000 annual exemption at once.For single taxpayers, thismeans a one-yearcontribution ofup to$75,000[$15,000 annual exemption x 5 years].For married taxpayers filing jointly, the maximumone-yearcontributionjumps to $150,000 [$30,000 annual exemption x 5 years].Although thesegiftsare made tax-free, the IRS requiresthatyoumake a special electionby filing a gifttax return.
How can BWM Financial help?
As part of our service toclients,BWM Financialwill evaluate the tax-efficiency of your current giftingand estate planning strategy.We canlook at yourfullfinancialpictureandshow you the mosttax-advantagedways oftransferringwealthtoloved ones withoutimpacting your lifestyle or future needs in anyway.
Our Director of Wealth Planning,ChrisPegg, and other advisorscanworkdirectly with your CPAand estate attorneytohelp you createmore advancedestate planningstrategiesif needed.These strategieswill be covered inourupcomingarticlesandinvolve Grantor Trusts, Family Limited Partnerships,Charitable Remainder Trusts and more.
If you need help withestateplanning, please contact BWM. While we are not tax advisors, wewill provide high-level advice that can be evaluated with yourCPA and estate attorneyand then put into action.
