Tuesday, June 06, 2023

A young woman brings home her fiance to meet her parents. After dinner, the mother tells her husband to find out about the young man. The father invites the fiance to his study for a drink.

“So what are your plans?” the father asks the young man.

“I am a Torah scholar.” he replies.

“A Torah scholar? Hmmm,” the father says. “Admirable, but what will you do to provide a nice house for my daughter to live in, as she’s accustomed to?”

“I will study,” the young man replies, “and God will provide for us.”

“And how will you buy her a beautiful engagement ring, such as she deserves?” asks the father.

“I will concentrate on my studies,” the young man replies, “God will provide for us.”

“And children?” asks the father. “How will you support children?”

“Don’t worry, God will provide,” replies the fiance.

The conversation proceeds like this, and each time the father questions him, the young man insists that God will provide. Later, the mother asks her husband, “How did it go?” The father answers, “Well, the bad news is he has no job and no plans, but the good news is he thinks I’m God.”

As you may have suspected I heard that joke from an older man in shul a few years back. I promised myself I would never become the old-guy-with-the-jokes-in-shul-guy. Everyone seems to always run away from that guy. So my purpose was not to pointlessly repeat that joke. But as the well-known adage goes, behind every joke, there’s a little bit of truth. And the truth is, we have a tendency to be very philanthropic, especially when it comes to our children. While this is a commendable trait, one should know the possible tax consequences of bestowing large gifts to anyone.

The relevant tax issue at hand is referred to as the gift tax. While a short article merely presents the tip of the iceberg of this exhaustive topic, the basics are still valuable knowledge for all taxpayers. The first thing to know about the gift tax is that the donor and not the recipients is responsible if the tax is indeed imposed. The gift tax is intertwined with the estate tax. The reason it was initiated was because many people were giving away most of their money and property before they died, thus avoiding the estate tax. See, when someone dies and an estate is inherited by his/her survivors, Uncle Sam wants a piece of that action. So when people found a loophole to get around the estate tax, Congress passed a bill to close that loophole in the form of the gift tax. By limiting the gifts you can give away while alive, it assures the government that they will get something in the end for the larger estates. The term “gifts” in this article can be in the form of cash, stocks, real estate, or other tangible or intangible property.

The second thing to know is that you will not owe the tax until you’ve given away more than $5.43 million in cash or other assets during your lifetime (as of 2015; this routinely adjusts for inflation). Your spouse is entitled to a separate $5.43 million as well. So practically speaking, actually owing the gift tax is not very common. However, it is much more common that one is required to file gift tax returns even though no tax will be imposed. What most people know about the gift tax is that you are allowed to give up to $14,000 (as of 2015) a year to as many people as you wish before the gift tax is applicable. It is commonly mistaken that for any gift above this threshold the donor must pay gift tax. However, the rule isn’t that you will owe tax necessarily, it just means that you will have to file a gift tax return, Form 709 with the IRS. The basic rule is as follows: gifts that are not above the $14,000 threshold do not reduce the $5.43 million lifetime exemption, and gifts above the $14,000 threshold will reduce the lifetime exemption.

As an example, you gave your two favorite children $25,000 each this year as a gift, and your least favorite child $12,500 because you like him half as much as the others. Under the gift tax rules, the gift of $12,500 is completely ignored and does not count against your lifetime exemption of $5.43 million. However, for the other two gifts of $25,000 each, these gifts will reduce your lifetime exemption by $22,000 [($25,000—$14,000) x 2 = $22,000]. So in this example your lifetime exclusion is now $5,408,000. You would have to file a gift tax return to show the gifts in excess of $14,000, however no tax would be imposed, assuming the lifetime exclusion has not been met. Think of it like the IRS keeping a bar tab on you. For those that can afford to do so, making annual gifts up to the $14,000 threshold is a great way to reduce your taxable estate.

It should also be noted that there are special rules governing contributions to a 529 college savings plan. This special rule allows you to make a lump-sum contribution and allocate it over a five-year period for gift tax purposes. For example, you can contribute $70,000 in 2015 to your grandchild’s 529 college savings account and for gift tax purposes it will be viewed as a gift of only $14,000 per year for each of those years. The result is that this will not trigger the need to file a gift tax return and it will not reduce your lifetime exemption. If you’re married, your spouse can do the same. The one limitation is that if you give additional gifts to that same recipient during that five-year span, then it will trigger the gift tax return and count against the lifetime exemption.

Lastly, one should know that certain gifts are exempt from these requirements. Gifts to your spouse (if a US citizen) and to IRS-approved charities are exempt. Gifts to cover another person’s medical expenses are also exempt if the payments are made directly to the medical provider. Similarly, gifts to cover another person’s tuition expenses (this does not include room and board or books) are exempt if paid directly to the institution.

Daniel Magence, CPA, Esq. is a principal at Pristine CPA Solutions, LLC (www.pristinecpa.com). Pristine CPA Solutions offers tax and accounting services to individuals and businesses of all sizes. He can be reached at [email protected] or 201-326-6908 if you have any questions, comments, or are interested in using Pristine CPA’s services. It’s tax season now, so feel free to contact us for a free consultation.

By Daniel Magence

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