Giving Gifts to Individuals: Some Basic Questions Answered

What factors other than taxes should I consider in deciding whether or not to make a gift?

Given your net wealth, liquidity, income, age, health, and family obligations, consider whether making the gift would jeopardize your economic independence or standard of living. Remember that gifts can be made of property other than cash – stock, shares in mutual funds, insurance policies or premium payments, debt forgiveness, and ownership interests in a family business or in real estate can all be given away. Keep in mind that once an outright gift is made, the gift recipient (the “donee”) may dispose of the gifted property in any way he or she wishes – whether or not you would have approved.

Also consider the age, ability, and financial circumstances of the intended donee. Making outright gifts to a minor or to an incapacitated person may involve the appointment of a conservator to manage the property given. Making an outright gift to a donee who has little or no financial experience may be unwise.

Are there ways to ensure that a gift is used as I intended?

Giving a gift to a trust for the benefit of the intended donee can ensure that the property is well managed by a trustee and that the gift is used in a way you would want. For example, you could limit use of the gift for educational and support purposes and prohibit its use to pay gambling debts. A trust arrangement would also eliminate the need for a conservator for an incompetent or minor donee. Setting up a trust will involve tax and administrative issues and will involve some expense. Therefore, in most cases, trusts should be used only when the gift will be substantial.

What types of taxes may be involved if I make a gift?

Making a gift may have gift tax, estate tax, generation skipping transfer tax, and/or income tax consequences. This article will address only the gift and estate tax consequences. A future article will discuss the income tax and generation skipping transfer tax consequences of making gifts.

What is the federal gift tax?

The federal gift tax is a tax on the transfer of property by a gift during any taxable calendar year. The gift-giver (the “donor”) is responsible for paying any gift tax due. However, if the donor does not pay the tax, the donee may have to pay.

Are any types of gifts not subject to the gift tax?

Under current tax law, a donor may make tuition payments directly to an educational institution and may pay medical expenses (including medical insurance premiums) directly to the individuals or organization providing the services without incurring gift tax or having to file a gift tax return.

Outright gifts to a US citizen spouse need not be reported on a gift tax return and no gift tax need be paid. However, gifts of certain types of “terminable interests” to a spouse must be reported.

In addition, a donor currently may give up to a total of $12,000 in gift value each year to as many donees as desired without having to file a gift tax return or pay gift tax. This amount is known as the “annual exclusion” from gift tax and it is indexed for inflation each year. The annual exclusion amount for gifts made to a spouse who is not a US citizen is presently $120,000. However, in order to qualify for the annual exclusion, the gift must be of a “present interest.” Generally, this means that the donee must have immediate access to the gift.

Married couples may elect to “split” their gifts. In that case, although only one spouse makes a gift exceeding the $12,000 annual exclusion, both spouse’s annual exclusions are applied to that gift (up to a total of $24,000 per donee) to exclude the gift from gift tax. If spouses elect to split a gift, they must split all of their gifts for that calendar year and each must file a gift tax return.

Under what circumstances must a gift tax return be filed?

If a gift to a donee exceeds the $12,000 annual exclusion amount (even if the gift is split) or is not of a present interest and thus does not qualify for the annual exclusion, a gift tax return must be filed to report the gift. Then, either a gift tax must be paid or a portion of the lifetime exemption from gift tax must be used.

What is the lifetime exemption from gift tax?

The lifetime exemption from gift tax equals $1,000,000 per person. No actual gift tax need be paid until a donor’s lifetime gift tax exemption is used up. To the extent that the $1,000,000 lifetime exemption is used, it reduces the exemption from federal estate tax available at a donor’s death.

What is the federal estate tax?

The federal estate tax is a tax imposed upon the transfer of a deceased person’s entire taxable estate. The estate tax exemption is currently $2,000,000 per person. That is, the first $2,000,000 of a person’s property is not subject to estate tax.

Give an example of how the gift and estate tax relate to each other.

Although a deceased donor who has made $500,000 in taxable lifetime gifts will have paid no out of pocket gift taxes, that donor’s estate tax exemption will be reduced by those lifetime taxable gifts – from $2,000,000 to $1,500,000. However, if gift tax was paid, the donor will be given credit for lifetime gift taxes paid. Lifetime gifts that qualify for the annual exclusion will not reduce the gift tax exemption amount and thus also will not reduce the estate tax exemption amount.

Are there any estate tax advantages to making lifetime gifts?

Making lifetime gifts can be a good strategy for reducing your taxable estate below the estate tax exemption amount. Not only is the gifted property itself removed from your estate, the income that was earned and the appreciation in the value of the property that accrued since the gift are also eliminated. Thus, the amount given away will not be subject to estate tax. If the gifts qualified for the annual exclusion or other exemptions, often no gift tax will have been paid and no estate tax exemption will have been used up.

The estate planning attorneys at Berry Moorman are experienced in helping clients consider the varied options and tax and estate planning consequences of making gifts. For additional information or assistance, contact one of our attorney in the Estate Planning Group.