The concept of “tax-free gifts” can sound counterintuitive. Of course you have to pay sales tax when you buy a gift, and you paid taxes on the income that you used to purchase the gift, but beyond that, why would there be a tax?
This is a good question, but there is in fact a gift tax in the United States. This tax is in place to stop people from giving gifts in an effort to avoid the federal estate tax. These two taxes are unified, and they both carry a 40 percent top rate at the present time.
The existence of the gift tax is the bad news, but there is also some good news. It is possible to give tax-free gifts to your children by using the exclusions that are available to you.
Annual Gift Tax Exclusion
There is an annual per person gift tax exclusion. Each taxpayer can give as much as $14,000 to individual gift recipients within a calendar year without facing any gift tax exposure. To be clear, you can give any total amount of money gift tax-free, but to use this exclusion, you cannot give any one person more than $14,000 within a calendar year.
We should point out the fact that there is an unlimited marital deduction, so you can give unlimited tax-free gifts to your spouse. However, you would have to use your exclusion to give a tax free gift to a child, or anyone else for that matter.
Since each taxpayer has a $14,000 per person, per year gift tax exclusion, if you are married, you and your spouse could combine your respective exclusions. This would allow you to give each of your children as much as $28,000 per year in tax-free gifts.
This can be a great advantage if you are exposed to the federal estate tax, because you could use this exclusion to transfer assets tax-free each year. You could give direct gifts, but you could also use the annual exclusion to fund certain types of trusts, and it could be used to distribute shares in a family limited partnership.
Medical and Educational Gifts
You can pay school tuition and medical expenses for others without incurring any gift tax exposure, because there is an educational exclusion, and there is a medical exclusion.
Unified Lifetime Gift and Estate Tax Exclusion
There is a unified lifetime gift and estate tax exclusion that exists in addition to and apart from the annual per person exclusion. The amount of this exclusion is $5.43 million in 2015. You could use a portion of this exclusion to give a tax free gift to someone that exceeded $14,000 in a calendar year.
However, if you use all of your unified lifetime exclusion giving tax-free gifts, there would be nothing left to apply to your estate.
Without question, the rules that govern tax-free asset transfers can be confusing. If you would like to discuss everything with a licensed professional, contact us through this page to set up a consultation: Sacramento CA Estate Planning Attorneys.