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 $14,000 per year on or after January 1, 2014, without the giver incurring a tax penalty or having to report the gift. Further, gift givers can subtract amounts more than $14,000 from a lifetime exemption amount (without having to pay taxes on it) known as the unified credit. This amount stands currently at $5.34 million per person. 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 federal estate tax when you die. For example, if you use $2 million of your unified credit, your estate tax exclusion would be $3.34 million instead of $5.34 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. For example:
- 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 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 once he or she exhausts the lifetime exemption amount, or unified credit. Luckily, the yearly limit isn’t $14,000 in this case – in 2014, you may give up to $145,000.
- 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 property, the $14,000 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 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’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.
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.
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?