As we approach the end of the year, we often get questions from our clients and friends regarding gifting. Almost everyone has heard of the $14,000 annual exclusion for gifting, but what exactly does it mean? And how does it coordinate with the lifetime estate tax exemption?
We hope the following will answer some of your questions.
1. Does the recipient of a gift have to report the gift as income? No. The receipt of a gift is not considered to be income, no matter how large the gift.
2. Do I get a tax deduction for making a gift? No. Just as the recipient does not report income, the donor does not get a tax deduction.
3. So what is gift tax? Gift tax, which is coordinated with estate tax, is a TRANSFER tax not an income tax. Every US citizen has a lifetime exemption ($5,340,000 in 2014 increasing to $5,430,000 in 2015) which allows them to transfer up to the exemption amount either during the life or at death without incurring estate or gift tax. Any gift or bequest in excess of the exemption amount is taxed at a top federal rate of 40%.
4. What is the annual exclusion amount? The annual exclusion amount of $14,000 is the amount that you can give to any recipient during a calendar year, without coming under the gift tax reporting requirements. If your gifts to a single person exceed $14,000 in a year, then the excess is considered to be a “taxable gift” and there is a requirement to file a gift tax return, Form 709, because the excess gift is offset against the lifetime exemption amount. So if you give $30,000 to an individual in 2014, the $16,000 that is in excess of the annual exclusion must be reported on a gift tax return, and will reduce the $5.34 million lifetime exemption, but no tax will be payable until gifts exceed the lifetime exemption amount.
5. What about family members? Do these rules apply to them? Yes.The rules for gifting apply to all individuals, regardless of whether they are family members.The only exception to this is in the case of spouses. If your spouse is a US citizen, the usual limits on lifetime gifts do not apply, and you can transfer assets, even if they exceed the annual exclusion amount, and generally you are not required to file a gift tax return.
6. My spouse is not a US citizen. Do the same rules apply? No. If your spouse is not a US citizen, any transfer in excess of $145,000 in any year will reduce the lifetime exemption and a gift tax return is required to be filed.
7. My son is married with two children. How much could my spouse and I gift to them each year using the annual gift exclusion? Since each spouse has an annual exclusion of $14,000 for each donee, you could make a combined gift of $112,000 – $14,000 each to your son, his wife and their two children.
8. I have some stock that is worth $14,000. I paid $1,000 for it. Would it be a good idea to gift it to my son? Maybe. If you sold the stock, and gave the cash to your son, you would owe capital gains tax on the $13,000 gain. Since your son carries over your basis in the stock, he will also be taxed on the gain if he sells the stock. If he is under age 19 or a college student under age 24, “kiddie tax” will ensure that he is taxed at your bracket on any gain over $2,000. But if there are no current plans for him to sell the stock, this could be a good idea.
9. Are there any gifts that are not included in the $14,000 exclusion? Are there any gifts that are not considered taxable gifts even if they exceed $14,000? Yes. You can pay the medical, dental and tuition expenses of any person without the payments counting towards any of the limits. But you must make these payments directly to the provider in order for them to be excluded. So you could pay $60,000 of tuition for someone and still give a $14,000 gift in any year, as long as the tuition costs are paid directly to the educational institution.
10. What about 529 plans? A 529 plan provides the opportunity for saving for future generations’ higher education expenses and allows tax-deferral of any growth in the plan. Contributions to a 529 plan DO count against the $14,000 annual exclusion, but there is a provision that allows you to put 5 years of annual exclusion gifts ($70,000 or $140,000 for a married couple) into a 529 plan at one time. The ability to “seed” the plan with a lump sum can allow the assets to grow tax-deferred more quickly. However, this forward-gifting provision does require the filing of a gift tax return, and also means that no other annual exclusion gifts are allowed for this beneficiary in the five year period.
11. I realize that we should have filed gift tax returns several years ago. Will I be penalized if I file them now? No. As long as there was no tax due, then there is no penalty for late filing.
12. I have a life insurance trust and my children are the beneficiaries. Do the premiums on the life insurance count as gifts to my children? Maybe. The premiums can qualify for the annual exclusion if the trust contains certain “Crummey” provisions and if you follow those provisions exactly, which means sending out annual notices to the beneficiaries of the trust. Contact our office if you have more questions regarding this. If the premiums do NOT qualify for the annual exclusion, they are considered taxable gifts and a gift tax return is required to be filed.
13. Can the annual exclusion gift be used to gift partial interests? Yes. For example, you and your spouse own a piece of rental property that you would like to transfer to your 4 children. You may choose to transfer the property to an LLC and then gift partnership interests to the children. If you obtain an appraisal of the partnership interest being gifted, you could use the same appraisal to make gifts on December 31 and again on January 1, which could allow to transfer $56,000 of value to each child without being required to use your lifetime exemption, more if you included the children’s spouses in the gift. One major caveat though. Gifting an interest in a property to the spouse of a child may not be what you want to do. Gifts to a child are treated as that child’s separate property as long as the asset is kept separate, so in the case of a divorce, the asset would stay with your child. Extending the gift to the child’s spouse just in order to avoid a taxable gift may be a short-sighted strategy.
Please contact our office if you would like to talk about any of the items discussed above.