Are you considering transferring wealth, assets, or property to your heirs? You may be in for a much more difficult – and costly – procedure than you realize. While giving to those you love is wonderful, you must be aware that giving isn’t free.
If you’re in a position to help out younger family members or friends, or if you’re contemplating how to best transfer your estate to your heirs, it is crucial to understand gift tax regulations. Some gifts aren’t subject to any tax, but many are. A quick study of the numbers and rules can prevent you from taking an unnecessarily large tax hit and help you plan how to transfer your wealth. In addition to familiarizing yourself with gifting rules, contact an estate planner or attorney to make sure your heirs receive everything they’re entitled to.
What Is a Gift?
Leave it to the IRS to take a word that sounds pleasant and give it a complicated definition. Basically, any financial assistance or monetary transfer – direct or indirect – is a gift in the eyes of the IRS, so long as the person receiving the cash doesn’t reciprocate with something else of the same value.
By that definition, gifts come into play in many situations, such as overpaying a friend or family member just to help them out. If you overpay and do not receive something in exchange of equal value, such a gift could be subject to taxes. Generally, though, a friendly transaction like this one would have to be blatant and extreme for the IRS to take notice.
Gift taxes are paid by the person who gives the gift in all but the rarest of circumstances. But don’t confuse generosity with charity - you can’t deduct gifts on your tax return.
Understanding the Gift Tax
Any individual can accept a gift up to the federal gift tax exclusion amount, which is $13,000 per year (through 2012), without the giver incurring a tax penalty or having to report the gift. That amount rises to $14,000 in 2013. Further, gift givers can subtract amounts more than $13,000 from a lifetime gift tax exclusion amount (without having to pay taxes on it) known as the unified credit, which currently stands at $1,772,800 for 2012. However, they must report these gifts to the IRS by filing a gift tax return, or Form 709.
One of the tax system’s checks and balances is that contributions that reduce the unified credit also reduce an individual’s estate tax exclusion. For example, if you use $100,000 of your unified credit during your lifetime, and the estate tax exclusion is $1 million, your heirs may only receive $900,000 tax-free.
As long as your individual gifts are less than gift tax exemption amount for each recipient, you may give to as many individuals as you’d like; you won’t reduce your unified credit or, in turn, your estate tax exemption.
Fortunately, there are plenty of circumstances in which you can provide assistance, but needn’t declare that assistance as a gift. For example:
- Education - If you pay your niece’s college tuition, even if it costs more than $13,000 per year, it isn’t considered a gift. In fact, education expenses can be at any education level, not just college.
- Health - If your brother has heart surgery and you pay the bills because he doesn’t have health insurance, or if your grandmother needs assistance and you pay for a home health aide, the cost would not be considered a gift.
- Spouse - If you and your spouse maintain separate bank accounts or investment accounts, you may give each other as much money as you’d like without considering it a taxable gift. There is one catch: You must both be American citizens. If you’re not, the spouse who isn’t a citizen is subject to the yearly limit.
- Politics - You may donate to political organizations without paying any taxes. These are not charitable donations, however, so you can’t deduct them on your return.
Different Forms of Gifts
When gifts take the form of stocks or real estate property, the $13,000 per person limit still applies. Gift givers must use fair market value to determine if gift tax applies. For example, if you give the gift of stock shares, you’d calculate the market value of your stock on the day it’s transferred. If you are gifting property, you must get an appraisal to determine the current value. You should also provide the recipient with your cost basis – how much the stock or property cost you when you bought it – because he or she will need to use that to figure out their gain if they sell it.
Consider if you bought 100 shares of stock at $10 each, but the day that you transferred it to your son, the shares were worth $100 each. If your son holds them for a few years and then sells them at $120 each, he’ll have to pay capital gains tax on $110 per share of stock – the $120 he sold them for, minus the $10 you bought them for.
Similarly, if you gift your daughter a house that was worth $100,000, but you purchased it for $60,000, even if she sells it for $100,000 she still must pay taxes on $40,000. However, it pays to speak with a qualified estate planner and tax professional to best determine how to transfer your wealth and avoid excessive capital gains.
Gift tax rules are very complicated, so it’s best to consult a CPA when considering this financial move. Keep in mind that if you are married, even if you file taxes jointly, you and your spouse need to fill out separate gift tax forms - Form 709 - since you each have your own unified credit “bank” to use up during your lifetime.
Most people enjoy giving to their family and friends, and with the rising limits on gift tax exclusions, it’s becoming easier for everyone. Are you planning on using gifts to reduce your estate or help your family?
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