By Jeremy A. Wechsler, Esq.
Investment Advisor Representative
Gifting is one of the most powerful (and misunderstood) tools in estate planning. Done correctly and strategically, it can reduce taxes, preserve wealth, and benefit your loved ones or favorite charities. I’ve created a comprehensive guide covering gifting rules, strategies, tax implications, and key pitfalls to avoid. Whether you’re considering a gift to a family member or exploring charitable giving, this resource will offer insights you won’t want to miss.
Introduction To Gifts:
What is a gift? To an estate planner, a gift is more than just a token of appreciation or a check for your birthday. “Gifting” can be a strategic planning move for legacy planning, tax planning, long-term care planning, and more.
It just so happens that those who engage in this strategic gifting also desire to help certain charities or family members. In other words, you can have the best of both worlds. The tax laws have evolved over the years to carve out two tax categories for gifting—annual gifts and lifetime gifts. Both categories are “exemptions” from federal estate taxes, but also in Pennsylvania, an exemption from Pennsylvania inheritance tax.
Before I dig into the details, it is important to understand that gifting has a variety of consequences, both positive and negative. If you’re considering making large gifts, or engaging in strategic planning, I strongly advise you to seek counsel from an attorney, a financial advisor, and perhaps a CPA. With that, let’s dig into it.
Types of Gifts:
- Annual Gifts: You can give up to $19,000 per person, per year, without needing to report it to the IRS or paying gift tax. There’s no limit on how many individuals you can gift to in a year. You can make $19,000 gifts to as many people as you would like. This number has shifted over the years, and will continue to do so (it was $10,000 forever). Annual gifts are powerful, as they do not count towards your lifetime gift/estate tax exemption (see below).
- Education/Medical Gifts: You can make gifts of educational or medical expenses on behalf of another person in unlimited amounts, but the payments must be made directly to the institution.
- College Savings Plans (529s): You can make annual contributions up to the annual gifting limit to a child’s 529 plan. But you can also make a “Super 529” contribution—up to five times the annual gifting amount ($19,000)—in one year, provided you don’t make any additional contributions in the following five years. In other words, front-loading the annual gifts. 529s in general have many tax advantages, and laws have expanded how/where you can use 529 funds. Also, student aid eligibility laws are now favorable for grandparents to establish a 529 plan for a grandchild.
- Lifetime Gifts: The lifetime gift exemption is tied to the federal estate tax exemption. Right now, that exemption is very large—almost $14 million per person. You can give away up to $14 million either during your lifetime, at death, or a combination of both. Your annual gifts (the $19,000 gifts) do not count towards the lifetime gifts, and amounts at the annual gift level or below are not reported for tax purposes. Any gift amount above $19,000 would have to be reported to the IRS, and the IRS would count that amount towards your lifetime exemption. If you go over the exemption, the tax rate is large—40%! Exemptions change over time. Twenty years ago (2005), the exemption was $2 million. The exemptions have increased over the last twenty years, but in the future, it is possible for the exemption to again decrease. Last year, some planners urged clients to use their entire exemption up through gifting, since that was the only way to “grandfather” the high exemption amount.
The bottom line is that you have a lot of gifting power. Transferring assets out of your estate while you are living means less taxes for your heirs in the future, and the enjoyment of the property now. It’s worth noting that your heirs/gift recipients do not pay any gift taxes or income taxes on gifts. This is true for federal income tax, and Pennsylvania income tax. For other states, you should check with a professional in that state to be sure.
Pitfalls and Mistakes of Gifting:
So, what are some pitfalls and points of caution in making gifts?
- Gifting highly appreciated assets: Gifting a highly appreciated asset, such as a stock you have held for a long time, or a home you have owned for thirty years, is generally not a strategic gift. This is because the recipient will be responsible for the taxes on the appreciated value, whereas property held until death will receive a “step up in basis.” This means that all of your capital gains are wiped out upon death, a major advantage. For example, if you bought Apple stock 20 years ago for $5 per share and it’s now worth $150, gifting it would pass the entire capital gain ($145) to the recipient. Instead, holding onto the stock and passing it along to heirs upon your death allows the gifted stock to receive a step-up in basis, wiping out the capital gains tax for your heirs.
- Gifting & Long-Term Care: When planning for long-term care costs and trying to preserve your estate for your heirs, keep in mind that making gifts/asset transfers is subject to a five-year look-back period for Medicaid. Medicaid does not care that other laws “allow” you to make large gifts. For the purposes of Medicaid, you cannot make transfers and then expect immediate coverage for long-term care costs.
- Loss of Control: Once an asset is gifted to someone else, you lose all control over it. If you gift your house to your son but remain a resident in the house, and he subsequently gets hit with a large creditor claim, your house (nope, his house) could be at risk of being taken away. Be careful and thoughtful before making large gifts.
Gifting Strategies:
Gifting has a lot of tax advantages, and there are a variety of strategies from simple to complex to take advantage of gifting rules and craft a plan that best suits you. For instance, clients with large estates that include businesses may want to use a “GRAT” (Grantor-Retained Annuity Trust) to take advantage of some estate tax planning tools.
Other clients may use their annual gift exemption to fund life insurance premiums inside a trust, which could mean the death benefit is outside of your estate for tax purposes upon death.
Charitably minded clients have a variety of tools at their disposal to make charitable gifts while also benefitting their families.
Finally, clients may use an irrevocable trust for long-term care planning to transfer highly appreciated assets out of their name legally, but not for tax purposes (so as to preserve the “step-up” advantage upon death). These trusts also allow for more control of the transferred property.
The advanced strategies come and go, as it’s always a cat-and-mouse game between Congress, IRS, courts, and taxpayers.
Conclusion:
Understanding gifting rules and laws can be complex, so it is best to speak with a professional before starting a gifting program or making major gifts. Anyone can write a check, but are you being strategic about your gift and looking at every possible angle?
For gifting questions, please contact me at your convenience and we can work through strategies and ideas.