One part of overall estate planning is considering how to minimize taxes as much as possible. This includes not only estate taxes but also gift taxes. When you transfer ownership of property, even as a gift, the IRS will impose a tax. There are some exceptions or exclusions to the gift tax that is typically imposed. Here is what you need to know.
First, what is considered a gift?
According to our federal government, a gift is “any transfer to an individual, either directly or indirectly, where full consideration is not received in return.” There are few exceptions, such as when you pay tuition or medical expenses for someone else. Those payments are not considered taxable gifts. Also, gifts made to spouses, political organizations and qualified charities can be deducted on your personal tax return.
What is the Annual Gift Exclusion?
The most important exception, however, is the Annual Gift Exclusion. This exclusion makes gifts that do not exceed the annual exclusion amount for that calendar year exempt from taxes. The Annual Gift Tax Exclusion amount for 2016 is $14,000 per recipient. Put more simply, you can give away as much as $14,000 during the calendar year to any one recipient you choose, without any tax consequences. You can give as many of these $14,000 gifts as you choose to different people, including family, friends or strangers.
In other words, there is no limit on how much you can give away, as long as you do so in increments of $14,000 or less to each person each year. An added bonus is that, if you are married, you and your spouse can combine your gift tax exclusions so that your gift can be as much as $28,000 for each recipient.
Are there any restrictions?
There is one important requirement. The annual gift exclusion only applies to gifts of “present interest.” That means the person must receive an unrestricted right to immediate possession, use and enjoyment of the gift or the exclusion will not apply. Therefore, a birthday check that allows the recipient to spend the money in any way they choose conveys a “present interest.” However, an irrevocable trust that does not allow the recipient to have any access to the money until they reach a certain age would instead be a gift of a future interest. The annual gift exclusion would not apply in that situation.
What is the unified credit and what role does it play?
In addition to the gift tax exclusion, there is also an estate tax exclusion that exempts a certain portion of an estate from taxes. These two exclusions — the gift tax and estate tax exclusions — are often referred to as the unified credit. Together they provide a lifetime exclusion of $5.45 million as of 2016. This can be seen as the lifetime gift exclusion limit. This amount is subject to change each year. This lifetime exclusion means that $5.45 million of your estate will be exempt from estate taxes when you die. The unified credit is also “portable” so that, if you did not use the full amount of your unified credit, the remainder will pass to your spouse when you die.
What happens if you exceed the lifetime exclusion amount?
If you exceed the $5.45 million lifetime exclusion amount, you will be required to pay 40% gift tax on gifts that exceed that amount. This does not apply to gifts made to your spouse, which are unlimited, as long as he or she is a U.S. citizen. This is often referred to as the unlimited marital deduction.
Making the most of your annual gift exclusion
In order to make the most of your annual gift exclusion, remember that this exclusion is based on the calendar year – January through December. You cannot go back and claim a year you may have missed, but you can spread a large gift over two or more years and still avoid gift tax consequences. So, for instance, if you are giving a $20,000 gift to your grandchild, write one check for $10,000 in December 2016 and another check for $10,000 in January 2017. If you plan it that way, both gifts will remain tax-free.
If you have questions regarding any estate planning needs, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.