Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible and, in turn, the gift recipient sometimes thinks income tax must be paid on the gift received. Nothing is further from the truth. To fully understand the ramifications of gifting, one needs to realize that gift tax laws are related to estate tax laws.
When a taxpayer dies, the value of his or her gross estate (to the extent it exceeds the excludable amount for the year) is subject to estate taxes. Naturally, individuals want to do whatever they can to maximize their beneficiaries’ inheritances and limit the estate’s amount of inheritance tax. Because giving away one’s assets before dying reduces the individual’s gross estate, the government has placed limits on gifts, and if those gifts exceed the limit, they are subject to gift tax that must be paid by the giver.
Gift Tax Exclusions – Certain gifts are excluded from the gift tax.
- Annual Exclusion – This is the annual amount that an individual can give to any number of recipients. This amount is adjusted for inflation, and for 2011, it is $13,000. For example, a taxpayer with five children could have given $13,000 to each child in 2011 without any gift tax consequences. The taxpayer cannot deduct the dollar value of the gifts, and the value of the gifts is not taxable to the recipients. Generally, for a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the recipient’s enjoyment of the gift can’t be postponed into the future. For gifts to minor children, there is an exception to the “present interest” rule where a properly worded trust is established.
- Lifetime Limit – In addition to the annual amounts, taxpayers can use a portion of the federal estate tax exemption (it is actually in the form of a credit) to offset an additional amount during their lifetime without gift tax consequences. However, to the extent this credit is used against a gift tax liability, it reduces the credit available for use against the federal estate tax at the taxpayer’s death. For 2011, the credit-equivalent lifetime gift tax exemption is $5 million and is the same as for the estate tax exemption.
- Education & Medical Exclusion – In addition to the amounts listed above, there are two additional types of gifts that can be excluded from the gift tax:
(1) Amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual.
(2) Amounts paid by one individual on behalf of another individual directly to a provider of medical care as payment for that medical care. Payments for medical insurance qualify for this exclusion.
If, during the year, your gifts exceed the sum of the annual, education, and medical exclusions, you are required to file a gift tax return (even if you have not exceeded the lifetime limit).
Gifts of Capital Assets – Sometimes a gift might be in the form of securities, real estate, or other items that have appreciated in value. In these situations, the gift value is the item’s fair market value at the time of the gift. However, when the recipient of the gift sells that asset, he or she will measure his or her gain from the giver’s tax basis. For example, a parent gifts 100 shares of XYZ, Inc. worth $9,000 to his or her child. If the parent originally paid $5,000 for the shares and if the child sold the shares for $9,000, the child (the recipient) would be liable for the tax on the $4,000 gain. In effect, the parent (giver) transferred the taxable gain in the stock to the child. This can be beneficial from a tax standpoint if the child is not subject to the “kiddie tax” rules and is in a lower tax bracket than the parent. Caution: Watch out for unintended gifts such as an elderly parent placing a child on the title of the home or other assets.
Gift-Splitting by Married Taxpayers – If the gift-giver is married and both spouses are in agreement, gifts to recipients made during a year can be treated as split between the husband and wife, even if the cash or property gift was made by only one of them. Thus, by using this technique, a married couple can give $26,000 a year to each recipient under the annual limitation discussed previously.
If you have additional questions or would like this office to assist you in planning an appropriate gifting strategy, please give us a call.