As the holidays grow close, the challenges of 2020 may have led you to consider giving gifts of money or assets to loved ones. Maybe you want to give cash to help with bills or a down payment on a house, or you’d like to transfer ownership of a house to someone.
If so, there may be no better time than now. The temporary increases in the Lifetime Estate and Gift Tax Exemption provided by the Tax Cuts and Jobs Act (TCJA) can help you potentially lower the taxes owed by your estate.
The Gift Tax is a federal tax that the Internal Revenue Service (IRS) imposes on transfers of money or property while getting nothing (or less than full value) in return. The rates range from 18-40% and are usually paid by the giver. The point of the gift tax is to prevent people from avoiding the federal estate tax by giving all of their assets away before they die.
Annual Gift Tax Exclusion
The Annual Gift Tax Exclusion allows you to give anyone up to a specified amount of money each year without affecting your taxes. For 2020 the limit is $15,000 per recipient. The recipient could be your son, great aunt, dog walker, Lyft driver, anyone. If you’re married, your spouse can give $15,000 to anyone as well. Gifts between spouses are excluded from gift and estate taxes.
The purpose of the Exclusion is to prevent taxpayers from having to report every gift given during the year, such as giving their grandchild a gift worth $100 for their birthday, or giving their daughter $2,000 to put towards her honeymoon. For once common sense ruled the day and the Exclusion was created to avoid time-consuming paperwork that benefitted no one. As long as you give each person $15,000 or less, there is nothing else you need to do.
Lifetime Estate and Gift Tax Exemption
The Lifetime Estate and Gift Tax Exemption, on the other hand, allows you to give a large amount during your lifetime and through your estate without paying gift taxes on it. Before TCJA was passed in 2017 that exemption was $5 million. TCJA temporarily changed that amount to $10 million plus adjustments for inflation. For 2020 the exemption is $11.58 million. If you are married, your spouse can use the full exemption as well.
As an example, let’s say that you have decided to pay for your grandchild’s college education, and the first year will cost $100,000.
Annual Exclusion – 15,000
Gift after Exclusion $ 85,000
If the Lifetime Exemption didn’t exist, you’d have to pay gift tax on $85,000. Let’s take it further and include the Exemption:
Lifetime Exemption $11,580,000
Gift after Exclusion – 85,000
Remaining Exemption $11,495,000
By taking the remaining $85,000 out of the Lifetime Exemption, no tax will need to be paid on the gift.
How Does this Help with Taxes?
If you have substantial assets, gifting the assets now allows you to transfer it at its current value, keeping any appreciation between now and your death out of the estate. For instance, if you transfer ownership of your vacation home to your son now, and it’s currently valued at $500,000, the amount deducted from your Lifetime Exemption would be $485,000 after the Exclusion. But if you kept it, and it was worth $1 million when you died, the entire amount would be deducted from your Exclusion as it passed through your estate.
But what if you don’t have over $11 million in assets that you’re looking to give away? How does this benefit you? Let’s say you want to give someone $150,000 to help with a down payment on a house. Without the exemption you would have to give them $15,000 for 10 years ($30,000 for 5 years if you’re married) to avoid paying gift taxes. With the exemption, you can give it to them all at once.
Why is Now a Good Time?
The exemption increases provided for in the TCJA are not permanent, it is set to expire in 2025 and will decrease to around $6 million beginning January 1, 2026. That timeframe is not guaranteed, Congress can change tax laws at any time, and there are no assurances that there won’t be changes before 2025.
On the bright side, if you were to give $11.58 million now and then the limit is reduced, the IRS has decided that there will be no clawback of gifts; they won’t retroactively charge tax on the excess. If the lifetime limit is decreased after you give the gift, the additional amount you gave will not be subject to estate taxes in the future.
How Do I Take Advantage of This?
The simplest method of using the exemption is to give an outright gift, provided you are willing to give up all control of the asset. Once it is given, you have no legal say in what the recipient does with it.
Another option is to put the asset in a trust, which can offer the giver more control over how the asset is used. A trust may be beneficial to those who are reluctant to give sizeable gifts due to the potential need for assets in the future. There are several types of trusts, and many ways to structure management and distribution of the assets in the trust. If you are considering establishing a trust, consult with an estate attorney and a CPA or Enrolled Agent with experience in trusts and estates.
The Bottom Line
The current tax laws offer a rare opportunity to gift a substantial amount while avoiding paying gift/estate taxes. Because it is a limited time offer, it may make sense to gift the assets now rather than wait for them to pass to your estate.
The issues surrounding gifts are complex. Every tax situation is unique, and what works for one person may not for another. Before you make any irrevocable decisions, consult with a tax and estate professional to determine what is the best course of action for you.