Countless individuals make gifts to charity every year not only to support their favorite philanthropic causes but to also take advantage of tax savings in the form of a deduction on their 1040 income tax return. As you may be well aware from conversations with your accountant or tax preparer, there is no similar income tax deduction for gifting to one’s children and loved ones. However, there are potential estate tax benefits for making such gifts that you may want to consider.
What is the “Gift Tax” Anyway?
Any direct or indirect transfer to an individual where full consideration (measured in money or money’s worth) is not received in return is considered a gift. All gifts are “taxable” unless they fall within one of the exceptions discussed below.
When we say a gift is “taxable” or is subject to the “gift tax”, that does not mean there is some actual tax payment made to the I.R.S. or New York State. What it means is that your estate tax lifetime exclusion amount is lowered by the value of all the taxable gifts made during your lifetime. Taxable gifts are reported on form 709 filed with the I.R.S.
Currently, the federal estate tax lifetime exclusion amount for 2014 is $5,340,000. In New York, the estate tax lifetime exclusion amount is currently $2,062,500 but will gradually increase to the federal level. So if a single filer made $114,000 worth of gifts to one child today, their federal estate tax lifetime exclusion amount would be reduced to $5,240,000.
Tax Advantages of Gifting.
If you anticipate having an estate over the federal or New York estate tax lifetime exclusion amount and have excess assets (e.g. cash) that you do not need for your own living expenses, you can make annual exclusion gifts (see amount below) to whomever you wish without having to reduce your lifetime exclusion amount and thus potentially reducing your estate tax liability when you pass away.
For example, assume you pass away today with an estate valued at $5,440,000. Assuming no deductions are available, your estate will be subject to federal and New York estate taxes. If you had made $100,000 worth of annual exclusion gifts during your lifetime to the same individuals you bequeathed your estate to anyway, your estate would have avoided federal estate taxes altogether.
Lifetime gifts also have the advantage of excluding future appreciation in the gifted assets from transfer tax until the donee re-transfers the property. By contrast, if the property is retained until death, all appreciation up until death will be subject to estate tax.
Note however that gifting property during the donor’s lifetime means that the property will not receive the benefit of a “stepped-up” income tax basis that assets passing through the donor’s estate are typically entitled to. Please keep this in mind if you are considering gifting any “low-basis” asset. For example, a parcel of real property purchased decades earlier that has now appreciated significantly in value.
Annual Gift Tax Exclusion Gifts.
In addition to a lifetime exclusion amount the I.R.S. provides for an annual gift tax exclusion (currently $14,000). This exclusion applies to each donee, thereby enabling a significant number of annual donee exclusions, if desired. If, for example, you have three children and perhaps multiple grandchildren, you can donate $14,000 to each child and grandchild.
Annual exclusion gifts do not require the filing the aforementioned form 709 gift tax return.
Transfers by spouses.
If you and your spouse want to donate property you own together, you are each entitled to the annual exclusion amount on the gift. In other words, you and your spouse can currently give $28,000 to each donee. If a donor wants to use his or her spouse’s annual exclusion, he or she can exclude $28,000 per donee if his/her spouse consents on a timely filed gift tax return.
Other “Tax-Free” Gifts.
There are other types of gifts that are considered non-taxable besides those that do not exceed the annual exclusion for a given calendar year. Such gifts include: (1) tuition or medical expenses you pay for someone (i.e. the educational and medical exclusions); (2) gifts to your spouse; and (3) gifts to a political organization for its use.
Payments made under the educational and medical exclusion must be made directly to the educational institution or medical care provider on behalf of the donee and for the qualified purpose. In other words, a trust set up to pay future medical or education expenses for another person will not qualify.
New York Treatment of Gifts.
One final note, please be aware that New York recently enacted legislation that requires taxable gifts made after March 31, 2014 to be included in a New York resident decedent’s estate for New York estate tax purposes if the gift is made within three years of death. Annual exclusion gifts discussed above are not included. The purpose of this provision is to close a perceived “loophole” that allowed New Yorker’s to reduce or avoid New York estate tax by making “deathbed” gifts.
Conclusion
If you anticipate having an estate in excess of the federal or New York estate tax lifetime exclusion amount and are willing to forego some of your assets during your lifetime, you may want to seriously consider gifting assets now to save on potential estate tax liabilities later when you pass way. Your children and loved ones will undoubtedly have no objections to your newfound generosity.