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Annual Gift Tax Exclusion

Gifts and the Gift Tax

What is a gift?  For IRS purposes, a gift is a transfer of property for less than its full value, and is potentially subject to federal tax.  This is the gift tax.  The gift tax exists to prevent people from circumventing the estate tax by giving away all their money or other assets (i.e. “gifting” their money) right before they die.  It is important to note that the tax is owed by the giver of the gift, not the recipient.

So far the definition of “gift” sounds fairly all-inclusive, right?  Well, it is and it isn’t.  There are some things that aren’t considered taxable gifts.  Charitable gifts, gifts to a spouse who is a US citizen (gifts to a foreign spouse are subject to an annual limit of $148,000 in 2016), gifts of educational expenses (tuition only, not books or room and board) and gifts of medical expenses are all exempt from the gift tax.  (However, educational and medical expenses must be paid to the provider directly to qualify.)  The government also grants each individual a lifetime gift tax exemption ($5.45M per person in 2016), meaning that every individual can give away up to the exemption amount in total over their entire lifetime without having to pay the gift tax.  Anything over the exemption limit is subject to the gift tax, which is currently set at 40% for 2016.

How Much Can You Gift?

In addition to the five million dollar exemption, each individual can gift up to $13,000 per year, to any number of people, without any gift tax implications.  (So if you want to give ten people $14,000 each, every year, you can do so without having to pay gift tax or reduce your lifetime exemption amount.)  This is called the annual gift tax exclusion.  Any gifts in excess of $14,000 to any individual is subtracted from your lifetime exemption limit, while simultaneously reducing the amount that can be transferred tax free at death (known as the estate tax exemption).  So, if you give someone $20,000, your lifetime gift tax exemption and estate tax exemption are both reduced by $6,000 (the amount in excess of $14,000).

There are a few ways to avoid using part of your lifetime exemption and still gift more than the $14,000 limit to any one individual.  Since each person is entitled to the $14,000 annual exclusion amount, you and your spouse, if you have one, can collectively give away $28,000 per recipient per year, without having to pay gift tax or reduce your lifetime exemption.  You can also gift up to $70,000 into an educational account (also known as a 529 plan) to the same person in one year, so long as you do not give that person any more gifts in the next five years. (In essence, using up five years worth of the exclusion limit at once).  After this, any additional gifts to the same individual would then utilize a part of your lifetime exemption.  It is important to note that no gift tax return (Form 709) is required as long as you make gifts at or under the $14,000 annual exclusion.  If your gifts exceed $14,000 to any one individual, a gift tax return is required even if no gift tax is owed (because you are using some of your lifetime exemption).

Gifting to Minors 

Gifts to children can also be tricky.  A parent’s support payments for a child are not gifts if they are part of a legal obligation, but they can be considered a gift if the child is not a minor, or if the payment is not part of the parent’s legal obligation.  You can gift up to $14,000 outright to a child, or you can give the gift through a custodial account.  Under this type of account, the minor is considered the owner of the gifted property, but it is held, managed and distributed by a custodian.  When the minor reaches the age of majority (which varies depending on the state, but is age 18 in California) the property passes to the beneficiary outright.  (Note though, that the parent or grandparent who gifted the funds should not be named as the custodian of the account, as the account will be included in the donor’s estate should the donor name himself or herself as custodian and die while maintaining control over the account.)

A Crummey trust can be used in a similar way.  The annual exclusion amount can be gifted into a Crummey trust for the benefit of an individual.  The trust gives the beneficiary the right to withdraw their share of the gift within 30 days; if the beneficiary does not withdraw the gift during this period, the gift remains in the trust for use as the trustee directs.  Since the recipient does have the ability to use the gift immediately if they choose, this meets the requirement of being a “present-interest” gift, and so qualifies for the annual exclusion up to $14,000 of the gift.  For more information about this type of trust, see related article.

Advantages to Giving Gifts

The advantages to giving these annual exclusion gifts is that they eliminate assets from your estate, and eliminate the possibility that these assets will appreciate as part of your taxable estate, both of which will reduce your estate’s tax liability.  The gifts can also be very helpful to the recipients in receiving an education, buying a home, starting a business, or other worthwhile pursuits.  And the donor gets the added benefit of seeing the money put to use during their lifetime, and enjoying the good feelings of giving.  Lastly, gifting assets now can be a useful tool in teaching family members (especially younger family members) to manage wealth, while enabling you to monitor their ability to handle their future inheritance.

By Genevieve Hoffman 7/7/10; updated in 2016

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