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 interrelated with estate tax laws.
When a taxpayer dies, his or her gross estate (to the extent it exceeds the excludable amount for the year) is subject to estate taxes. The exclusion for taxpayers dying in 2012 is $5.12 million. In addition, there is an unlimited spousal deduction for married couples. The amounts in excess of these exclusions are subject to inheritance taxes as high as 35%. Naturally, individuals want to do whatever they can to maximize the inheritance to their beneficiaries and limit the amount of inheritance tax on the estate. Since giving away one’s assets before he/she dies 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 2012, it is $13,000 (increases to $14,000 in 2013). For example, a taxpayer with five children can give $13,000 to each child in 2012 without any gift tax consequences or the need to file a gift tax return. This amount includes all gifts made to the individual during the year, including birthday, holiday, and special occasion presents, as well as one-time gifts of money or property. The taxpayer cannot deduct the gifts, and the gifts are 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. There is an exception to the present interest rule where the recipient is a minor and the terms of a trust provide that the income and property may be spent by or for the minor before the minor reaches the age of 21, with the balance going to the child at age 21. This allows parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.
- 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 $5.12 million during their lifetime without gift tax consequences. Note that the $5.12 million is for 2012 and is expected to be substantially lower once Congress decides upon the 2013 rates. 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.
- Education & Medical Exclusion – In addition to the two dollar limitation amounts listed above, there are two other types of gifts that can be excluded from the gift tax, regardless of the amount given:
(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.
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 in a lower tax bracket than the parent and isn’t subject to the “kiddie tax” rules that tax the child’s income at the parent’s tax rate.
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 in 2012 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.