Are you considering transferring wealth, assets, or property to your heirs? You may be in for a much more difficult – and costly – effort than you realize. If you’re in a position to help out younger family members or friends, or if you’re wondering how best to transfer your estate after you pass on, it’s important to be aware that it isn’t always free.
Some gifts are not subject to tax, but many are. A quick study of the IRS gift tax regulations can prevent you from taking an unnecessarily large tax hit and help you plan how to best transfer your wealth. In addition to familiarizing yourself with IRS gifting rules, it’s also advisable to 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 perfectly simple and 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 giving money to a friend or family member just to help them out. Or, if you “overpay” and do not receive something in exchange of equal value, it’s considered a gift and 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. However, 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 $14,000 per year on or after January 1, 2015, without the giver incurring a tax penalty or having to report the gift (the exclusion amount remains $14,000 for the 2016 tax year). Further, gift givers can subtract amounts greater than $14,000 from a lifetime exemption amount (without having to pay taxes on it). This is known as the unified credit. This amount was $5.43 million per person in the 2015 tax year, and is $5.45 million in the 2016 tax year. However, givers must report these gifts to the IRS by filing a gift tax return, or Form 709.
Keep in mind, however, that tapping your unified credit reduces the amount that can be excluded from your federal estate tax when you die. For example, if you use $2 million of your unified credit in 2016, your estate tax exclusion would be $3.45 million instead of $5.45 million.
As long as your individual gifts are less than the annual gift tax exclusion amount, 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.
- Education: If you pay your niece’s college tuition, even if it costs more than $14,000 per year, it isn’t considered a gift. In fact, education expenses aren’t considered gifts 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 a yearly limit once he or she exhausts the lifetime exemption amount, or unified credit. Luckily, the yearly limit isn’t $14,000 in this case – in 2015, you could have given up to $147,000 (in 2016, you can give $148,000).
- 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, the $14,000 per person limit still applies. Gift givers must base their numbers on fair market value. For example, if you give a 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 – so the recipient can calculate the gain, should they sell it.
Suppose you bought 100 shares of stock at $10 each, but the day you transferred them 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 has 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. Regardless of your particular situation, it pays to speak with a qualified estate planner and tax professional to best determine how to transfer your wealth and maximize your tax strategy.
Also, keep in mind that you and your spouse may gift the annual limit separately. So each of you may separately gift up to $14,000 to the same individual, for a total of $28,000 before paying taxes. This applies to jointly shared property as well. So, if you and your spouse jointly own a plot of land worth $25,000, you could gift it to your son or daughter without tax penalty because you would each be gifting the equivalent of $12,500 – an amount less than the $14,000 limit.
Most people enjoy giving to their family and friends, and with the rising limits on gift tax exclusions, it’s becoming easier for everyone. The rules are very complicated, though, 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.
Are you planning on using gifts to reduce your estate or help your family?