How to avoid gift taxes
We have received several inquiries this year from clients who want to make a financial gift to a family member but were concerned about gift taxes. For most U.S. citizens, even if the gift is large, the answer to the question, “How much is the gift tax?” can be “not one red cent” with proper planning.
What is the gift tax?
Under current tax law, if a person accumulates enough assets, an estate tax can be imposed upon death. The estate tax becomes an issue once the taxable estate reaches a threshold amount which increases with inflation each year. In 2017, that threshold is $5,490,000 per person or, with good planning, $10,980,000 per couple. The estate tax is imposed based upon what is owned and transferred at death to heirs. The tax can be as high as 40%.
Note: Tax code changes doubled the amount that can be left or gifted to $11,200,000 per person beginning in 2018.
The gift tax uses the same scale as the estate tax but applies to transfers made while one is alive. It is generally charged to the donor not the recipient.
Because the estate tax rate is so high, someone near the end of their life has a strong incentive to give their assets away…
Because the estate tax rate is so high, someone near the end of their life has a strong incentive to give their assets away so their heirs could claim the assets were not part of the estate and avoid the tax. By imposing a tax on gifts, the ability to make “deathbed” transfers to avoid the estate taxes is reduced.
What is a gift?
What is and isn’t a gift seems like a straightforward issue but from a tax code perspective, there are some nuances worth noting. We will cover two here.
First, the transfer of an asset to another generally must be a full and actual transfer of ownership. The term in the tax code is a “completed gift.” The transfer cannot be contingent upon an event or action and the donor cannot have the ability to get the asset back.
There are gifting techniques which allow funds to be used for the donor’s benefit. For instance, a gift can be made to a trust that pays the donor income for a specified time period, after which the assets shift to a beneficiary. (This technique can be complex and is beyond the scope of this primer, but we wanted to acknowledge not all gifting involves the immediate and full surrender of an asset.)
Second, the value of the gift is typically the fair market value of the asset when the gift is completed, not what the donor wants to claim the asset is worth. Since the taxes are based on the value, donors have an incentive to claim assets are worth less than they really are. For gifts of cash or assets like publicly traded securities, valuing the gift is straightforward while other assets such as real estate, art, and jewelry can be more challenging.
What are the exclusions from the gift tax?
Many lifetime transfers are exempt from gift taxes. Just as you can leave an unlimited amount to your spouse or qualified charities upon your death without estate taxes, you may give unlimited amounts to your spouse or to a qualified charity anytime during your life without gift taxes.
For gifts to other recipients, there is an “annual gift tax exclusion.” It was $10,000 for many years but in 2017 became $14,000. (This limit is indexed to inflation and should be modestly higher at some point in the future.) The exclusion permits you to gift up to $14,000 of assets each to as many people as you like during 2017.
Your spouse is also able to gift to you an unlimited amount and $14,000 to as many people as desired. Therefore, between the two of you, up to $28,000 can be gifted without incurring any gift tax. Keep in mind the gifting limit is per person per year. So, suppose you wish to give a gift to your son who is married. Both you and your spouse can gift $14,000 each to your son and his spouse for a total of $56,000 in gifts for 2017 with no gift taxes.
To avoid gift taxes on gifts that exceed the $14,000 exclusion, you may need to file a Form 709 depending on the amount and titling of the account from which the gift is made. This is a special tax form that is not found in the typical 1040 tax packet.
What you want this money to be used for can offer more exemptions and special rules. You can use up to your next five years’ annual exclusion in advance by making a cash gift of $70,000 (five times $14,000) to a section 529 college savings plan without incurring gift taxes. Got four grandchildren? Then $280,000 can be gifted at one time free from tax. (If additional gifts are made within five years, a Form 709 may be needed to avoid gift tax.)
A cash gift paid directly to a university for tuition on behalf of a student or paid directly to an institution for certain health care expenses are not subject to the annual limit and do not count toward the lifetime limit.
How do you avoid gift taxes on large gifts?
Earlier, we described how a married couple could give their son and his spouse a total of $56,000 in 2017 gift tax free by using their annual gift tax exclusions. What if they wanted to give $100,000?
Because the exclusion is available annually, if the need for the $100,000 is not urgent, they could simply make the gifts over two tax years. We often see this done in the fall. Our couple could give the $56,000 now and the rest after New Year’s.
Even if the annual limit is exceeded, gift taxes may still be avoided. Say a single man wants to give his only child $100,000. There is only one $14,000 annual exclusion amount available. By filing Form 709 and using some of his “unified credit,” no taxes are payable. All U.S. citizens get a credit against estate and gift taxes for the tax on estates equal to the exemption amount ($5,490,000 in 2017).
Here is how it works. He gives his son $100,000 which is $86,000 over the limit. So he files a Form 709, uses some of his credit, and avoids gift taxes. The ramification of this is that he can no longer leave $5,490,000 free of estate taxes. If he dies in 2017, he will only be able to leave $5,404,000 ($5,490,000 less $86,000) estate tax free.
For most, gift taxes are avoidable
Despite the complexity of our tax code, basic gifting goals can usually be satisfied with simple techniques and the right paperwork. For some families, there are issues that make things more complicated. Some beneficiaries would not handle a large gift responsibly. Some assets are not easily divided up. Differences in income tax brackets between donor and recipient can present other tax savings opportunities – or tax traps.
Nonetheless, one of the things we love about our clients is they are generous. We have facilitated many gifts to family, close friends, and charity over the years and we would be happy to help you should that be your desire.
Moisand Fitzgerald Tamayo, LLC is an Orlando, FL and Melbourne, FL based fee-only financial planner serving central Florida and clients across the country. Moisand Fitzgerald Tamayo, LLC specializes in providing objective financial planning, retirement planning, and investment management to help clients build, manage, grow, and protect their assets through all phases of one’s life and the many transitions in between.
If you have any questions or would like to discuss anything further, please give us a call or send us a note.
If you are not a client and wish to receive emails notifying you of new posts – no more than once per month – fill out the subscription information in the sidebar to the right.
Important Additional Information & Disclosures
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Moisand Fitzgerald Tamayo, LLC-“MFT”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from MFT.
Please remember that if you are a MFT client, it remains your responsibility to advise MFT, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. MFT is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. Tax advice is given only to clients and only when agreed to by MFT. A copy of the MFT’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request.
Please Note: MFT does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to MFT’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
Please Note: Limitations: While MFT does NOT pay for recognition, awards, or publicity, neither rankings and/or recognition by unaffiliated rating services, publications, or other organizations, nor the achievement of any designation or certification, should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if MFT is engaged, or continues to be engaged, to provide investment advisory services. Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized adviser. Rankings are generally limited to participating advisers. No ranking or recognition should be construed as a current or past endorsement of MFT by any of its clients. ANY QUESTIONS: MFT’s Chief Compliance Officer remains available to address any questions regarding rankings and/or recognitions, including providing the criteria used for any reflected ranking.
Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your MFT account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your MFT accounts; and, (3) a description of each comparative benchmark/index is available upon request.