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The holidays season is fast approaching and this traditional occasion for family and friends reunions is also the perfect time for gifting. Some of you may be even wondering how far you can go with your giving before it becomes a taxable event.
The Tax Cuts and Jobs Act, which brought the most significant changes to the income tax for businesses and individuals in the last few decades, had also a great impact on the estate and gift tax exemption, virtually doubling it.
Treasury Decision 9884, issued on November 26 and available on the Federal Register website, is a document which contains final regulations addressing the effect of recent legislative changes to the basic exclusion amount allowable in computing Federal gift and estate taxes. The final regulations will affect donors of gifts made after 2017 and the estates of decedents dying after 2025.
It seems appropriate to clarify that a gift is considered to be any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.
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The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. Gift taxes can be exceedingly high, with current federal rates of as much as 40%. However, there are a number of exclusions from the gift tax that generally means that only the wealthiest of taxpayers has to worry about paying anything to the IRS.
The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.
The donor is generally responsible for paying the gift tax. Under special arrangements the donee may agree to pay the tax instead. (Please check with your tax professional if you are considering this type of arrangement.)
The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.
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- Gifts that are not more than the annual exclusion for the calendar year.
- Tuition or medical expenses you pay for someone (the educational and medical exclusions).
- Gifts to your spouse.
- Gifts to a political organization for its use.
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In addition to these, gifts to qualifying charities are deductible from the value of the gifts made.
The unlimited marital deduction allows you to give any amount of money or property to your spouse, either during your lifetime or upon your death, without incurring either a federal or a state gift tax, if your spouse is a U.S. citizen.
If your spouse is not a U.S. citizen, however, the special tax-free treatment for spouses is limited to $154,000 a year in 2019 and $157,000 in year 2020 (this amount is indexed for inflation). That is in addition to the amount you can give away or leave to any recipient without owing federal gift/estate tax.s
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Contributions to a 529 college savings plan are gifts to the future student. A special rule allows you to make a lump-sum contribution and spread it over five years for gift tax purposes. For example, you can contribute $75,000 in 2019 to jump-start a 529 college savings account for your child. If you’re married, your spouse can do the same.
Payments that qualify for the medical exclusion include those made directly to a medical institution or care provider for the benefit of an individual. You can also make payment to a company that provides medical insurance to that person.
Gifts to political organizations are covered under Section 527(e)(1) of the Internal Revenue Code. Your gift must be used for the benefit of the organization, not passed on to anyone else. You can give to a few tax-exempt organizations as well as detailed under Section 501 of the Code. This can include civic leagues, horticultural and agricultural organizations, and labor organizations—although not labor unions. The organization must be classified as tax exempt under federal law.
You'd have to give away a considerable amount of money or property before you'd owe the gift tax, since gifts are only taxed when their value exceeds the lifetime exemption, the amount you are permitted to give away during the course of your entire life.
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The lifetime exemption only kicks in when you exceed this annual amount in a given year. The value of your lifetime gifts comes off the lifetime exemption first; then any exemption that is left over is applied to your estate's value.
Gifts made during your lifetime will reduce your taxable estate. However, gifts in excess of the annual exclusion also reduce your estate tax exemption.
The annual exclusion applies to gifts to each donee. In other words, if you give each of your children $11,000 in 2002-2005, $12,000 in 2006-2008, $13,000 in 2009-2012 and $14,000 on or after January 1, 2013, the annual exclusion applies to each gift. The annual exclusion for 2014, 2015, 2016 and 2017 is $14,000.
For tax years 2018, 2019, and 2020 the annual exclusion is $15,000.
If married, both spouses are each entitled to the annual exclusion amount on the gift. For 2019, the total for you and your spouse is $30,000. It is also important to mention that the gift does not have to be made in one lump sum.
The federal estate and gift tax exemption is indexed for inflation. The two taxes share the same exemption, which is adjusted periodically to keep pace with the economy.
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Recently, the Treasury Department and the IRS issued final regulations confirming that individuals taking advantage of the increased gift and estate tax exclusion amounts in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels.
Though the final regulations largely adopt the proposed regulations published last November, they also include clarifying technical language addressing concerns raised in several public comments as well as four examples which, among other things, illustrate the impact of inflation adjustments.
As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025.
In general, gift and estate taxes are calculated, using a unified rate schedule, on taxable transfers of money, property and other assets. Any tax due is determined after applying a credit – formerly known as the unified credit – based on an applicable exclusion amount.
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The applicable exclusion amount is the sum of the basic exclusion amount (BEA) established in the statute, and other elements, if applicable, described in the final regulations. The credit is first used during life to offset gift tax and any remaining credit is available to reduce or eliminate estate tax.
The TCJA temporarily increased the BEA for tax years 2018 through 2025, with both dollar amounts adjusted for inflation, as mentioned earlier. In 2026, the BEA will revert to the 2017 level of $5 million as adjusted for inflation.
To address concerns that an estate tax could apply to gifts exempt from gift tax by the increased BEA, the final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the BEA applicable to gifts made during life or the BEA applicable on the date of death.
Making a gift or leaving your estate to your heirs does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than gifts that are deductible charitable contributions).
If you are not sure whether the gift tax or the estate tax applies to your situation, refer to Publication 559, Survivors, Executors, and Administrators.
Generally, property you receive as a gift, bequest, or inheritance isn't included in your income. However, if property you receive this way later produces income such as interest, dividends, or rents, that income is taxable to you. If property is given to a trust and the income from it is paid, credited, or distributed to you, that income also is taxable to you. If the gift, bequest, or inheritance is the income from property, that income is taxable to you.
Finally, people who make gifts as a part of their overall estate and financial plan should engage the services of both attorneys and CPAs, as well as other professionals. The attorney usually handles wills, trusts and transfer documents that are involved and reviews the impact of documents on the gift tax return and overall plan. The CPA typically handles the actual return preparation and some representation of the donor in matters with the IRS. In addition, other professionals (such as appraisers, surveyors, financial advisors and others) may need to be involved during this time.
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Better yet, check our newsletters regularly to keep up-to-date with any new regulations impacting your finances and taxes.
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