In my last post, I wrote about year end charitable gifts. This time of year I also get questions about making financial gifts to family or friends. Clients ask, “How much can you give away without a gift tax?” or “What is the ‘gift tax’ and when do I have to pay it?” Below are the basics if you are thinking of making a financial gift this year.
The gift tax exclusion or annual exclusion is the amount of money that an individual can give to another free of federal estate tax. Or to put it another way, this is the amount you can give each year to another person without affecting your Lifetime Gift Tax Exemption.
The 2013 and 2014 annual gift tax exclusion amount is $14,000 per individual. Married couples can gift an unlimited amount to their spouse and up to $28,000 as a couple to another person without exceeding the annual exclusion amount.
For example, my client John and his wife want to “gift” the maximum amount to their three adult children. They can give each adult child $28,000 ($14,000 from John and $14,000 from Karen) for a total gift to their three kids of $84,000. Since their adult children are all married, they can actually gift up to $56,000 per couple ($28,000 x 2) for a grand total of $168,000. And if each of their three kids have three kids of their own, they could give… well, you get the idea.
What if the gift exceeds the annual exclusion?
Amounts that exceed the annual gift tax exclusion reduce your Lifetime Gift Tax Exemption. Lifetime Gift Tax Exemption is the total amount that can be given away by an individual during her lifetime that will be free of gift taxes. The amount gifted reduces the amount that can be passed free of federal estate tax at death.
The Federal Lifetime Gift Tax Exemption amount is $5,250,000. Double that for married couples.
Most people will never make a gift that exceeds the $14,000 annual gift tax exclusion amount. According to estate planning attorney Chris Stanton, “Making a gift that exceeds $14,000 doesn’t create a tax bill, but could reduce the amount of money that is passed tax free upon death”. Here’s a story to illustrate what would happen:
I have another client named Frank. Frank and his wife Pat recently purchased a house for $200,000. They have the cash to put 50% down on the property, but Frank’s parents would like to gift them the other $100,000 so that there is no mortgage.
Frank’s parents have a net worth that is less than $5,250,000, but that could change in the future. Frank’s parents could gift the entire $100,000 today even though it exceeds the $14,000 annual gift tax exclusion. If they do, $56,000 would be considered within the annual exclusion amount (Frank’s parents can gift $28,000 to Frank and $28,000 to Pat).
If they want to stay under the annual exclusion amount, they can make another gift of $56,000 in January 2014. Both gifts would stay under the annual gift tax exclusion, and when combined are more than enough to pay off the house.
If Frank’s parents decide to gift the entire $100,000 right now, that’s fine too. If they do that, $56,000 is within the annual gift tax exclusion. The remaining $44,000 would reduce their Lifetime Gift Tax Exemption such that Frank’s parents’ estate would be subject to federal estate tax if it exceeds $5,250,000 less $44,000 (the amount that exceeded the annual exclusion) or $5,206,000.
Why would you do this?
In the examples above, both sets of parents simply wanted to make a gift to their adult children and not create any tax problems down the road. Others might choose to do this as a way of managing their future estate tax liability. By transferring assets out of your estate during your lifetime you avoid any estate taxes on those assets in the future.
Although the Federal estate tax doesn’t kick in until an estate exceeds $5.25 million, the MN estate tax applies to estates of $1.0 million or more. According to Stanton, gifting assets during your lifetime can be a good way to reduce your future estate tax liability.
The fine print
The person making the gift is responsible for any taxes or tax forms that need to be filed. If your gift exceeds the annual exclusion amount of $14,000 you will need to file IRS Form 709 as well as any state gift tax forms that may be applicable.
Estate planning can be complicated. As with any tax or legal issue you want to consult with your attorney or tax advisor, and other appropriate professionals. For more information about the gift tax or estate planning, please contact me directly or reach out to Chris Stanton through his website www.klemp-stanton.com.
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