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Thursday, May 19, 2022
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For most of us, accumulating financial assets isn’t an end in itself. Rather, we accumulate assets as a means to realize other material benefits. In the present, accumulating financial assets may give us a greater sense of financial security; we don’t have to worry about paying for an auto repair, unexpected medical bill, or home maintenance issue. Over time, our accumulated assets may extend that sense of security into the future, providing for retirement and leaving an inheritance. Along the way, accumulated assets can be spent for our enjoyment: to go on vacations, obtain luxuries and engage in other pleasurable activities.

During a lifetime, some of our accumulated wealth may be used for the benefit of others; we may give assets to children or grandchildren, friends, and organizations we support. Giving while we are still alive allows us to see the impact of our generosity, and in some cases, it may help ensure that the gift is applied in accordance with our wishes (such as funding the college education of a grandchild today instead of leaving an inheritance to a spendthrift child).

Giving may also be financially advantageous in preserving wealth for future generations. If you’re a business owner, professional, or otherwise have concerns about exposure of your assets to creditors, you may be able to shield these assets by giving them to family members today. In a similar vein, assets transferred at a low valuation today may result in lower future estate tax calculations than if the assets had remained in your estate.

The essence of giving is simple: what once was mine is now yours. But for a variety of reasons (financial and legal), the government also takes an interest in our gift-giving, even to the point of assessing taxes on certain gifts. And because government is involved, the specifics and paperwork of giving can be complicated. However, an understanding of basic gift-giving concepts can make it possible for most people to give effectively and maximize the enjoyment from their gifts. The following section provides a broad overview of the Federal Gift Tax regulations.

Note: Property laws vary from state to state, particularly laws involving spouses and joint owners, and almost every gift will have some transfer stipulations—how to title the account, when transfer occurs, etc. And because some gifts may be deemed fraudulent conveyances or attempts to circumvent the law, most gift transactions are subject to some form of legal review. Those issues should be discussed with competent legal professionals.

Unrestricted Gifts

There are several types of gifts that do not trigger a gift tax calculation. They are:

Gifts to a spouse.

Charitable gifts.

Gifts to political organizations.

Gifts of educational expenses—as long they are paid directly to the educational institution. (The exemption applies only to tuition. Books, supplies and living expenses do not qualify.)

Gifts of medical expenses. Like educational gifts, they must be paid directly to the medical care provider.

The Annual Exclusion

Each year, an individual may gift a limited amount to as many individuals as he/she chooses without triggering the gift tax. This is known as the annual exclusion. The amount is indexed each year for inflation, and for 2015, the annual gift exclusion is $14,000. Considering the size of gifts some people may want to give, the $14,000 exclusion may seem low. But because of the wording of the exclusion, it is possible to gift quite a bit without exceeding the annual exclusion, particularly in family situations.

Because the exclusion applies to an individual, a husband and wife could each give their adult son $14,000 for a total of $28,000. If the son is married, the couple could also give their daughter-in-law another $28,000. Add a couple of grandchildren (at $28,000 each), and the parents could transfer $128,000 to their son’s family without exceeding the annual exclusion. In some multi-generational financial plans, systematic gifting that stays within the annual exclusion limits can play a prominent role.

The Lifetime Exclusion

In addition to the annual exclusion, the Internal Revenue Code and Treasury regulations allow individuals to gift a specific amount of assets over their lifetime. This number is also the amount that can be excluded for estate tax purposes at death. The current lifetime gift tax exclusion is $5.43 million per person. As an interesting variation on the concept of unlimited giving to spouses, widows and widowers can receive any unused lifetime exclusion from a deceased spouse. And similar to the “double giving” that couples are allowed under the annual exclusion, this enables them together to transfer up to $10.86 million tax-free, either during their lifetime or when the estate is assessed at the death of the surviving spouse.

Here’s an example to illustrate where the lifetime gift exclusion might come into play:

Suppose a husband and wife own a vacation property in a resort community. The property is currently valued at $1.5 million. Their only son and his family (his wife, and their three children) use the vacation home regularly, and the son has expressed an interest in keeping the property after his parents pass. Last month, a developer announced plans for an exclusive golf and residential community on land adjacent to the family home. This project promises to greatly inflate the values of existing homes, perhaps doubling or tripling their values.

The couple realizes it might be better to give their son title to the vacation home today, at a market value of $1.5 million, rather than waiting to transfer it at their death, when the value might be much higher. Later this year, they plan to give him the vacation home. From a gift tax standpoint, here’s what will happen:

The couple can give a total of $140,000 of the home’s market value using their annual exclusion (2 parents x 5 children/grandchildren x $14,000). The remaining $1.36 million ($1.5 million—$140,000) can be applied to the couple’s lifetime exclusion. Divided equally, this means each individual’s lifetime exclusion is now $4.57 million ($5.25 million—$680,000).

Reporting Ongoing Use of the Lifetime Exclusion

The IRS requires the reporting of gifts that exceed the annual exclusion and eat into the lifetime exclusion. Form 709—The United States Gift (and Generation-Skipping Transfer) Tax Return—is a 5-page form that registers not only the gift, but how its value was determined, along with a history of previous gifts, and whether this gift is being reported on another Form 709 (each Gift Tax Return is filed individually—there are no joint Gift Tax Returns). If a gift results in a tax liability, it is usually the responsibility of the donor to pay it, although under certain arrangements, the IRS will allow the recipient to pay the tax.

Under the right circumstances, gifting financial assets can be a huge benefit for both the donor and the recipients. But between the legal and tax requirements, gifting is serious business.

By Elozor Preil

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