Exclusions Change Every Year
The government has a vested interest in preventing individual taxpayers from passing their assets to friends and family without first paying taxes, so they created gift and inheritance taxes. Though these taxes have been established for year, they are constantly being modified – the most recent changes have unified the taxes with a 40 percent top tier tax rate.
Despite these rules, there are a couple of gift tax exclusions that the law provides to allow certain gifts to be made. They are the Lifetime Exclusion and the Annual Exclusion.
The Lifetime Exclusion is applied to each spouse of a married couple, and it allows a certain amount of money to be excluded from gift and inheritance tax. The amount is adjusted every year for inflation, and for the tax year 2015, the amount is $5.43 million.
If one spouse dies and the exclusion amount is not fully used, the portion that is left over can transfer to the surviving spouse, but in order for that to happen an estate tax return must be completed and filed for the decedent, no matter whether one would otherwise be required or not.
The Annual Exclusion allows an individual to give the maximum exclusion amount to as many recipients as they wish each year without having to file a gift tax return. The amount is adjusted periodically for inflation, and for tax year 2015 it is $14,000.
The Annual Exclusion is an individual contribution, which means that a married couple can give a combined total of $28,000 per year to as many recipients as they wish without having to file a gift tax return. If the $14,000 per individual is exceeded then a gift tax return will have to be filed and the amount in excess will be subtracted from the Lifetime Exclusion that is allowed. The gift only becomes taxable once the Lifetime Exclusion has been exceeded.
Though the Annual Exclusion is straightforward when gifts are made in cash, gifts can also be given in the form of property. This requires an assessment of the dollar value of the property’s fair market value at the time that it was given. It is important to remember that it is the gift giver’s tax basis that must be used when determining whether a property has built-in gains: if it does then the gift recipient will need to pay the applicable taxes should they dispose of the property in a way that creates a taxable event.
For example, if a father gives his son stock that is valued at $14,000 but which he originally purchased for $5,000 and the son later sells the stock for $16,000, the son’s taxable gain will not be the $2,000 difference from when he was given the stock to when he sold it, but the $11,000 difference from when his father originally bought it.
Using the same example, if the son receives the stock as an inheritance upon his father’s death then the tax basis would have been the fair market value at the time of the death. The taxable gain would only have been $2,000. It is important to point this out because it represents a mistake that many taxpayers make as they get older. In trying to distribute their property prior to their deaths, they end up leaving their heirs with larger tax liabilities then they would have had the distribution occurred as an inheritance, which bases gains on fair market value at the time of death. This happens with a number of assets, and can be particularly costly when it comes to high value assets such as real estate.
By way of example, if a woman originally purchased her home for $100,000 but transfers the title to her son when it is worth $500,000, her son’s sale of the house at that price results in a $400,000 taxable gain. Had she left the house to her son, the gain would have been calculated at the fair market value at the time of her death – a $500,000 house sold for $500,000 would result in no taxable gain.
Family members who wish to provide gifts for medical and educational expenses may find that certain contributions are excluded from the $14,000 Annual Exclusion, and are allowed without requiring a gift tax return. These expenses include tuition paid directly to the qualifying educational institution, even if the amount is over $14,000, and medical expenses paid directly to the qualifying medical institution or health care provider. These payments can also be made directly to the insurance company providing coverage. Neither of these types of expenses need to be included the $14,000 annual exclusion and they do not apply to the lifetime exclusion either as long as the payment goes directly to the provider rather than to the beneficiary.
The rules regarding gifts can be complicated, and if misinterpreted or misunderstood can result in tax repercussions. For more information about planning gift giving, call our office at (770) 474-0464 to set up a convenient time for a consultation.
Give us a call at 770-268-3434 and let us handle your tax questions and planning.