TAXES & TAXATION
GIFTING AND THE GIFT TAX
© 2007 by Eric Holk
Certified Specialist in Estate Planning, Trust & Probate Law
The State Bar of California Board of Legal Specialization
The federal government imposes a gift tax on certain lifetime transfers made by any individual. Each taxpayer can give away up to $14,000 per calendar year to an unlimited number of different people, and none of those gifts will be deemed taxable gifts (see “Annual Exclusion Gifts” discussion below for more detail). Transfers to any one person in any one year above the annual exclusion amount is considered a “taxable gift.” However, as of 2014, each taxpayer has the right to make taxable gift transfers of up to $5,340,000 total during his or her lifetime (above and beyond the $14,000 annual exclusion gifts) without actually having to pay any gift tax, even though such gifts are considered “taxable.” Lifetime taxable gift transfers in excess of the $5,340,000 will require the taxpayer to pay a gift tax of 40% on the excess. Only the amount above the $5,340,000 requires the payment of a gift tax; until you exceed the $5,340,000 grand total, no actual gift tax is due.
Example: In 2014, you make the following gifts:
$10,000 to Mick Jagger.
$14,000 to Emmylou Harris.
$5,354,000 to [somebody you love].
$20,000 to Hillary Rodham Clinton.
$20,000 to Rush Limbaugh.
The gifts to Mick and Emmylou fall within the $14,000 annual exclusion, so these gifts are neither taxable nor reportable. The other three gifts all exceed the annual exclusion, so those gifts must be reported. The first $14,000 of each of those gifts qualifies for the annual exclusion, so that part of each gift is not subject to gift tax. The amounts above the annual exclusion amount for each individual recipient will be deemed to be taxable gifts. Consequently, the reported taxable gifts will be:
$5,340,000 to your loved one ($5,354,000 minus $14,000)
$6,000 to Hilary ($20,000 minus $14,000)
$6,000 to Rush ($20,000 minus $14,000)
Total taxable gifts: $5,352,000
Minus exemption: - 5,340,000
Subject to gift tax: $12,000
Since these gifts total more than the $5,340,000 lifetime exemption amount, there will be a gift tax due and payable on the $12,000. At the 40% rate, this means a gift tax of $4,800 will have to be paid by the person who made the gifts. The taxpayer will have used up her $5,340,000 lifetime gift tax exemption, so unless Congress changes the law, any future gifts of more than $14,000 in any one year to any one person will result in the imposition of a gift tax.
Note that the RECIPIENTS of the gifts do not pay any tax on the gifts they get.
If the gift is comprised of assets other than cash (such as real property or shares of stock), the current fair market value of the gifted asset must be established, documented, and reported to the IRS if the gift is over the $14,000 exclusion amount. The recipient of the gift receives the giver’s tax basis in the gifted asset, so if the gifted asset is worth more than the giver paid for it, the recipient will be responsible for a capital gain tax if the recipient later sells the asset. Except for this potential capital gain tax liability, gifts are tax-free to the recipient. [Note: Some people seem to think that a gift to another person should be tax-deductible for the giver. This is not true for gifts to individuals. Only gifts to qualified charities are tax-deductible to the giver.]
The Gift Tax is intertwined with the Estate Tax (the federal tax on one’s estate at one’s death). To the extent that you have made taxable gifts during your lifetime up to $5,340,000, the total of those taxable gifts will be charged against and deducted from your federal estate tax exemption. Currently, the individual estate tax exemption is $5,340,000, which means that you can leave that amount of money to your heirs in 2014 without an estate tax. Estates larger than that normally will be subject to the estate tax to the extent they exceed $5,340,000. However, if you have made lifetime taxable gifts, that will reduce your future estate tax exemption dollar-for-dollar up to the full applicable exemption amount. The lifetime exclusion amount is adjusted annually for inflation, so this amount likely will increase in future years.
There are a few exceptions to the Gift Tax, which will be addressed below.
Gift Tax Exclusion for Interspousal Transfers
The gift tax does not apply to transfers between spouses (unless one spouse is not a U.S. citizen, in which case different rules apply). There is no limit to the amount of assets that can be transferred between spouses, but that applies only to husbands and wives, not to domestic partners or same-sex spouses, so far. Transfers between domestic partners still count as taxable gifts to the extent the amount transferred exceeds the annual gift tax exclusion.
Annual Gift Tax Exclusion
The law allows each taxpayer to transfer up to $14,000 per calendar year to as many people as he or she wants, without having to report those gifts to the IRS or have the gifts counted as taxable gifts. For example, if one wanted to make gifts to 3 other individuals, one could give each recipient $14,000 each calendar year ($42,000 total) without making any taxable gifts. Even if you made annual exclusion gifts of $14,000 to each of 1000 people (totaling $14,000,000) in one year, this still would not result in any gift tax. Only if you give more than $14,000 to any one individual in any one calendar year will you be required to report the excess as a taxable gift.
For persons who have taxable estates and who have the liquid assets with which to make annual exclusion gifts, it makes sense for them to do the maximum gifting each year to each of the persons who will ultimately be their heirs. This gets money out of the taxable estate without any gift or estate tax consequences, and if the recipient takes and invests the gifted funds, then all the future growth on those funds is also out of the giver’s taxable estate. Gifting also allows the giver to see what the recipient does with the gifted funds, and that may affect whether any further gifts might be made.
The annual exclusion amount is a cumulative total; it includes all gifts made to each person throughout the year, including birthday presents, Christmas presents, paying for a vacation trip for the other person, etc. Transfers of $10,000 or more made by check are reported to the IRS by your bank, so the IRS has the ability to monitor such transfers.
The annual exclusion amount is also adjusted for inflation. It used to be $10,000 per year for many years, then it went to $11,000; then in 2006 it rose to $12,000; in 2009 it rose to $13,000; and in 2013, it rose to $14,000. As inflation continues, eventually the annual exclusion amount will rise to $15,000, then $16,000, etc., but these changes only happen every several years.
For domestic partners, this annual exclusion amount becomes the annual limit of what can be transferred to one’s partner without triggering the gift tax. If you give more than $14,000 to any one individual in any one calendar year, the law requires you to file a federal gift tax return (IRS form 709) by April 15 of the year after the year in which the taxable gift was made. The first $14,000 of the gift is not “taxable,” but everything above that amount is deemed a “taxable gift.” For example, if you gave someone $100,000 in one year, you would file a gift tax return the next year showing an annual exclusion gift of $14,000 and a “taxable gift” of $86,000. Remember that you will not actually pay any gift tax unless and until the grand cumulative total of all your taxable gifts (excluding all annual exclusion gifts) exceeds the applicable gift tax exemption (currently $5,340,000 for 2014) during your lifetime.
When one has a taxable estate that is large enough to remain taxable to some extent even with a $5,340,000 estate tax exemption, it may be prudent to go ahead and use up some or possibly all of the $5,340,000 lifetime gift tax exclusion by making gifts to or for the benefit of the person or persons you know for sure that you want to leave the most, if you can afford to do so. By making “taxable” gifts of up to $5,340,000 now, even though this reduces your future estate tax exemption, it allows the gift recipient to take the money and invest it, and all future growth and income generated by that gift will also be removed from your taxable estate. Besides, you can still make the $14,000 annual exclusion gift to that person every year thereafter, since that annual exclusion amount is not counted in or charged against the $5,340,000 lifetime total.
Spouses and Gift-Splitting
For gifts made by a married couple (opposite-sex couples), each spouse can gift up to the annual exclusion amount ($14,000) to the same person. In other words, the wife can give $14,000 to someone and the husband can give another $14,000 to that same someone, and there is no taxable gift. For spouses who want to reduce the size of their taxable estate by giving money NOW to their intended beneficiaries, and who can afford to do so, they can give a combined total of $28,000 per year to each beneficiary without incurring an estate tax. You can include each beneficiary’s spouse and children as well, but this needs to be done carefully (see below on gifting to minors).
Each spouse should write a separate check for the annual exclusion gift amount, rather than have one spouse write a single check for $28,000 to one individual recipient. As far as the IRS is concerned, the spouse who writes such a check has exceeded the annual gift tax exclusion amount and therefore must file a gift tax return. It is still possible to claim “gift-splitting” on the gift tax return, which treats the gift as if half came from each spouse even though only one wrote the check. A spouse who has considerable separate property can double up on the annual exclusion gifts to individual beneficiaries, so long as the other spouse is willing to sign the gift tax return to exercise the “gift-splitting” option. The gift tax return (IRS form 709) must be filed to claim “gift-splitting” between spouses.
Charitable Gift Exclusion
There is no gift tax (or estate tax) on gifts to qualified charities, although you still have to report the gift if it is more than $14,000 to a single charity. (There are other rules on non-cash gifts to charities, but I won’t go into those here.) Likewise, gifts to qualified
charities are not subject to estate tax. Gifts to charities of anything other than cash or publicly traded securities may require an appraisal to establish the amount of the gift.
Note that gifts made to qualified charities during one’s lifetime provide the added benefit of an income tax deduction for the donor. Gifts made out of one’s estate will not produce any income tax deduction.
It should be mentioned that it is possible to do “split-interest” charitable gifts that provide both a gift to the charity and return of income to you as the donor (and/or to another person as well, if you wish) for life. Such gifts would only have gift tax implications if the present value of the future income stream to another person exceeds the $14,000 per year. Examples of this include charitable remainder trusts and charitable gift annuities. A full explanation of split-interest charitable gifts is beyond the scope and intent of this simple summary.
529 Plan Contributions
If you want to contribute to a 529 plan for a young person’s future college education, the $14,000 annual exclusion limit applies to those contributions as well, with one notable difference. One can contribute up to $70,000 in one year to a 529 plan and not have this treated as a taxable gift, but this uses up your annual gift tax exclusion for the beneficiary of the 529 plan for a period of five years (any additional contributions to the plan during that 5-year period will be a taxable gift).
Gift Tax Exclusion for Education Gifts
There is no gift tax on gifts made for another person’s education, although this is limited to tuition only (not other fees, room and board, books, etc.) and the payment must be made directly to the educational institution, not to the student or to the student’s parents. There is no limit on how much you can gift for another person’s tuition, and this applies to elementary school, high school, college, vocational/technical studies, and post-graduate education.
If you want to help pay for education expenses other than tuition, the $14,000 annual exclusion amount will apply to gifts made for those purposes. You can gift more than $14,000 per year, but the excess above $14,000 is considered a taxable gift.
Gift Tax Exclusion for Medical Expenses
Similar to the exemption for gifts for tuition, there is no limit to the dollar amount you can give to pay for another person’s medical expenses (doctors, hospital, health insurance, etc.), so long as the payments are made directly to the health care service provider. If you give the money to the individual so that they in turn can pay for their own medical expenses, you will be limited to the $14,000 annual exclusion if you don’t want to make a taxable gift.
What constitutes a gift?
Obviously, if you give cash to someone or write them a check, that is a gift. What many people don’t realize is that they may also be making gifts simply by adding another person on title to something they own. Whether such an action constitutes a taxable gift depends on the value of the asset and on what type of asset is involved.
Bank accounts. If you add someone’s name to a bank account (checking, savings, CD, money market, etc.), that alone does not constitute a gift to that person. However, if that person later draws money out of the joint account, the withdrawal of funds will result in a completed gift from you to that person for the amount withdrawn. If the amount they take is more than $14,000 total in any one year, you are deemed to have made a reportable taxable gift to them of the amount above $14,000.
Securities. For brokerage accounts, mutual funds, stocks, bonds, partnership interests, or any other such asset, the mere act of adding another person on title to the asset or account will be deemed a completed gift of half the value of the asset or account (assuming only two people are on title), even if nothing is sold or withdrawn. If the value of the asset or account is more than $28,000, then adding someone else on title will be a gift of half the value of that asset (assuming you were the only one on title prior to the gift), resulting in a reportable taxable gift of the value in excess of $14,000.
Vehicles. If you buy a vehicle for someone else and spend more than $14,000 for the vehicle, you have made a reportable taxable gift of the value above $14,000.
Jewelry, Art, Collectibles, etc. Gifts of such items also count as potentially taxable gifts if the current fair market value of the gifted item exceeds $14,000, although you are essentially on the honor system to report such gifts.
Real Estate. If you add another person’s name on as a co-owner of real estate, you are making a completed gift to that person of part of the value of the property. If you own it all, adding another person as a joint tenant constitutes a gift of half the net equity value of the property. If you add another person on as a tenant in common, you can specify a smaller ownership interest, such as 10%, as the gifted portion. With very few exceptions, adding someone as a co-owner of real estate in California will result in a reportable taxable gift and the property must be appraised to establish the value of the gift. [Note that if there is a loan on the property, adding another person on title could result in accelerating the loan, making the entire remaining balance due immediately.]
Many people have the notion that they can simply gift “$14,000 worth” of a given property to another person and thereby avoid the gift tax. Unfortunately, you cannot convey “$14,000 worth” of a given property to another person. You must first have the property appraised, then do a calculation to determine what percentage of the property can be conveyed without exceeding the $14,000 figure. For example, if your property is appraised for $700,000, you can give up to a 2% interest ($14,000) in the property to the gift recipient (as a tenant in common) if you don’t want to exceed the annual exclusion amount, assuming there is no mortgage on the property. If you want to gift more next year, another appraisal will be required. If the gift value exceeds the equivalent annual exclusion amount, a federal gift tax return must be filed.
There are other factors to consider when adding others on title to assets. For one thing, you now have exposed that asset to the other person’s creditors and potential litigants. If real property is involved, you must address who pays for such things as property taxes, insurance, repairs, maintenance, and (if the property is a rental) who gets the rental income. If the co-owned asset is sold, you need to realize that the other person will be entitled to keep part of the proceeds (and will be liable for part of the capital gain taxes, if any).
Gifting to Minors
You can give up to $14,000 each year to minors (persons under 18), whether or not you are related to them. However, if you plan to do this, it is best to do so in the form of a custodial account with an adult custodian in charge of the money until the minor reaches adulthood. Minors in California are not supposed to have more than $5,000 in their own name [CA Probate Code §3401]. California’s Uniform Transfer to Minors Act allows funds to be held in a custodial account until the young person is 21, so long as it states “to age 21” on the account. The money can be used for such things as the college education of the minor prior to age 21, but whatever remains in the account at 21 is supposed to be turned over to the young person, unless he or she makes an informed decision to leave the money in the custodial account after reaching age 21.
To make a custodial account gift, the new account should be set up as follows, and the check made payable to the adult custodian “as custodian for [the minor]”:
" as custodian for
[name of adult custodian] [name of minor]
under the California Uniform Transfer to Minors Act to age 21."
Virtually any asset may be gifted to a custodial account, including stocks, bonds, insurance and real estate, as well as cash. However, remember that gifts of appreciated assets can carry an unrealized capital gain tax liability that the minor will have to pay taxes on when the appreciated asset is sold.
Gifting with Life Insurance
$14,000 per year can buy quite a bit of life insurance, and it may be possible to get a policy that can be fully paid up after a period of years. If you gift money to another person who has an “insurable interest” in you (such as an adult child or a domestic partner) that person can use the gifted funds to take out a life insurance policy on you, with your prior knowledge and consent. If the gift recipient is the owner and beneficiary of the policy, then this can greatly increase the funds that will pass to that person upon your death. If that person is the primary beneficiary of your estate, it also provides liquid assets that could be used to help pay the estate taxes or other obligations when the time comes, without subjecting the life insurance proceeds to the estate tax. If you don’t own the policy, the policy proceeds are not includible in your taxable estate, even if you were the person whose life was insured. (If you own a policy on yourself, the death benefit proceeds will be included in your estate for estate tax purposes, no matter who gets the money.)
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