Give gifts without incurring a tax liability
As nice as it would be to simply gift our friends and loved ones without taxes being imposed on what they receive, Congress has stepped in and imposed rules and regulations to prevent this from happening. Both inheritance and gifts are currently taxed at a top rate of forty percent. Still, with careful planning there are ways to pass gifts on to the next generation without them having to take a hefty tax hit. Most notably, there are two exclusions — the lifetime exclusion and the annual exclusion — that can be applied to great effect.
The annual exclusion, which is subject to an annual inflationary adjustment, allows an individual to gift up to a specific amount each year to as many recipients as they like, without the recipient having to file a gift tax return. For tax year 2015 the amount is $14,000 per recipient, and each member of a married couple is permitted to give an individual up to the same amount. This means that grandparents could gift each of their grandchildren up to $28,000 in 2015 tax free, and give similar gifts each year to follow.
The lifetime exclusion is an amount that is also adjusted for inflation, and which stands at $5.43 million per person for 2015. An individual is permitted to give that amount over the course of their lifetime without it being subject to either gift or inheritance tax. Like the annual exclusion, the lifetime exclusion is applied separately to each spouse within a married couple, and if one spouse dies without having used up their lifetime exclusion the remainder that hasn’t been used can be transferred to their surviving spouse. All that’s needed to do this is to file an estate tax return.
The lifetime exclusion and the annual exclusion are separate and apart from each other, though if an individual gives a single recipient more than the $14,000 (in 2015) limit in the course of a year, then the amount that they go over is not only subject to a gift tax, but also is deducted against their lifetime exclusion.
One thing that is very important to remember when gifting property is that for tax purposes, its value is assessed based on its fair market value when it is given. This can work against the recipient when the giver is alive, as fair market value is determined based upon the giver’s tax basis in the property, and if there are gains realized then the recipient is the one responsible for those capital gains. By contrast, if the property is received as an inheritance after the giver has died, the fair market value is based upon the value at the date of the death. In most cases, property will have gained considerably in value between the time that it was originally acquired and the time that it is received, and therefore there is a much greater capital gain on property whose fair market value is assessed based on the date of purchase rather than on the date that the giver has died. Many elderly taxpayers make the mistake of giving property gifts during their lifetime, and unwittingly cost their beneficiaries significant amounts in taxes.
To understand how this works, consider this example. A man purchases stock for $5,000 and gives it to his child during his lifetime when the stock is worth $14,000. The child sells the stock for $16,000. This leaves the child with a taxable gain of $11,000. If the man had held onto the stock and the child had inherited it when the stock was worth $14,000, then their capital gain would be just $2,000. Similarly, if a woman puts her $500,000 home that she originally purchased for $100,000 into her son’s name and the son sells it, the property gain will be $400,000. If the son had inherited it when it was worth $500,000 and sold it for that amount, he would not be liable for any gains at all, and could keep the full value of the cash received.
In addition to the lifetime exclusion and annual exclusion, those who want to share their assets with loved ones are able to make tax-free contributions to certain expenses. Most notably, paying medical expenses or educational expenses for another person can be free of tax liability without falling into the category of either the annual exclusion or the lifetime gift limits.
In order to gift payments of tuition expenses without being liable for a gift tax, the payments need to go directly to the educational institution. These payments do not in any way affect or reduce the ability to gift the recipient an additional $14,000 in gifts. Medical expenses can also be paid to either a medical provider or qualified medical institution without impacting the gift tax ability. The institution receiving payments must be qualified, and can include either a medical provider or insurance company – what is most important is that the payment is not made directly to the individual incurring the expense.
There are many ways that you are able to give gifts to those in your life without them incurring a tax liability. If you have questions about any of this, or the tax impact of any other advanced planning, call our office today at (562) 445-3888.