Reducing Estate Tax - Gifts

Gifting property during your lifetime rather than transferring property in a will is appealing. Not only does it feel good to take care of your loved ones while living, but doing so could be beneficial for tax purposes. You could reduce your taxable estate by implementing planning strategies to minimize tax consequences.

Gifts Subject to the Federal Estate Tax

Generally, the federal gift tax applies to any transfer by gift of real estate or personal property that you made by any means, whether tangible or intangible. Such gifts would typically be subject to a transfer tax.

The gift tax is a federal tax on transfers of money or property to other people who get nothing (or less than full value) in return. The taxpayer in a gift tax situation is the giver. The giver, not the recipient, typically pays the gift tax. The gift tax is in addition to any other tax, such as federal income tax, paid or due on the transfer.

The Internal Revenue Service (IRS) places limits on how much you can gift someone each year. If you exceed the annual limit, you must report it on a gift tax return, and the excess of your contribution counts toward your lifetime gift limit. Once you exhaust your lifetime exemption, you may begin to owe gift taxes.

Gifts not subject to specific exclusions or exemptions are taxed at a current federal gift tax rate of up to 40%. The gifts are reportable by the person who makes them, not the person who received them. The taxpayer is considered the donor.

Federal Estate Tax Exemption

To avoid estate tax, your taxable estate must not exceed the exemption amount, which, as of 2023, applied to estates valued at over $12.920 million. The IRS provides information so you can stay updated on the gift and federal estate tax exemption.

If the value of your estate exceeds the exemption amount, your estate may incur federal estate tax liability at your death. Failure to engage in federal estate tax planning could reduce gifts to family members and loved ones by as much as 55% or more.

If the federal estate tax could apply to you, the information below will show you how to use lifetime gifting to reduce your estate tax liability, creating substantial tax savings.

Annual Gift Exclusion

The U.S. tax code contains a tax exemption rule called the annual gift exclusion, which is surprisingly straightforward. As of 2023, the annual exclusion amount for gifts is $17,000 per recipient per year. You may make unlimited $17,000 gifts in a year without incurring a taxable gift.

These gifts are tax-free to the grantor and the recipient. Gifts exceeding $17,000 per year are subject to the gift tax. Congress can change this amount. It is likely to increase with inflation in the future.

Doubling Your Gifts

If you're married, your gift tax exclusion amount doubles. You and your spouse can each give up to $17,000 per recipient per year. So, if you were married in 2023, you and your spouse could jointly give up to $34,000 per recipient per year tax-free. With simple tax planning, you can eliminate federal gift tax liability in many circumstances. Even if a wife or a husband gives a gift without the consent of their spouse, the gift is still assumed to be made by both spouses jointly.

Suppose Henry and Wilma are well into retirement and looking to help their granddaughter buy a house with her spouse. Under the annual gift exclusion, Henry and Wilma can give $68,000 tax-free. Each spouse can give $17,000 to their granddaughter and $17,000 to her spouse

Spousal Gifts

If you're married and your spouse is a U.S. citizen, there's no limit on the value of gifts you can exchange together, as any gift to a citizen spouse is tax-free. However, if your spouse is not a U.S. citizen, there's an annual limit on how much can be gifted ($164,000 as of 2023). Any amount beyond that is subject to the gift tax.

Gifts of Non-Cash Property

The annual gift tax exemption rules apply to stocks, bonds, and personal and real property. For example, if you and your spouse elect to give your entire stock portfolio (worth $40,000) to your friend, you may jointly give $34,000 worth of stocks and bonds the first year and the remaining $6,000 the following year without triggering the gift tax.

Giving Stock As a Gift

You can either sell stocks and give the proceeds to a recipient. If the stock you plan to gift has appreciated, you'd realize a capital gain on the sale and have to pay capital gain taxes. The capital gain tax rate depends on whether you held the stock for one year or less or more than one year). If the value of the stock has increased since you purchased it, it's likely a good idea to give the stock instead of selling appreciated stocks and gifting the proceeds.

If the stock price has decreased, it's probably better to sell the stock, realize a capital loss for yourself, and gift the cash proceeds to the recipient. When you give stock, the recipient assumes your cost basis and holding period.

For example, let's say you gave your daughter stock worth $10,000 when you purchased it ten years ago for $2,000. When your daughter sells, she'll owe long-term capital gains on future appreciation beyond the initial $2,000 cost basis.

Giving a Life Insurance Policy

When you transfer a life insurance policy to a beneficiary, the IRS regards the transaction as a gift. Under federal estate tax exclusion rules, if you transfer a policy with a present value of more than $17,000, you have made a taxable gift that exceeds $17,000.

Timing Gifts to Avoid the Gift Tax

There are also ways to gift portions of property over time to avoid the gift tax. For example, suppose that Frank and Jill, a married couple, want to give their fully-paid luxury car to their grandson Jimmy. The car is held jointly and has a fair market value of $68,000. If the couple first transfers Frank's interest in the car to Jimmy, this would constitute a gift of $34,000 (under their joint annual gift tax exemption of $34,000). Jill can transfer her $34,000 interest the following year so that Jimmy owns the car outright without triggering gift taxes.

The timing of your gifts can make a difference in how quickly you can reduce the size of your estate. The annual gift exemption is based on the calendar year, meaning you cannot retroactively date a gift.

However, there are ways to use the timing rules to your advantage. For example, if your son needs $25,000 for a down payment on his new home, you can give $17,000 in December and the remaining $9,000 in January.

Because the gifts took place in different calendar years, even if only a few weeks apart, no gift tax will be imposed, and you will have quickly reduced your estate by $25,000. Executing planning strategies can significantly reduce your probate estate.

Gift Tax Exclusion for Medical and Educational Expenses

Payments of a family member's medical expenses or education expenses are exempt from the gift tax reporting requirements. The payment for medical expenses must be made directly to the health care provider or to a company that provides medical insurance. With respect to educational payments, the donor must make the payment directly to the school in order to qualify for the exemption. The payment must be for tuition only; it cannot cover books and room and board.

A person who gives away more than $17,000 to any one person (other than their spouse) is technically required to file Form 709, the gift tax return. But when you pay for someone else's medical care or tuition expenses for education, no matter that gift's size, it is exempt from reporting requirements.

Gifts to Minor Children

If you plan on gifting substantial assets to a minor child, this raises management questions. Most of the time, you'll want an adult to manage the money until the child is old enough to take responsibility. Generally, a donor makes gifts to minors through either an irrevocable trust or a custodianship/guardianship.

When gifting to a minor child, either through an irrevocable trust or a custodianship, the gift must meet the following conditions to qualify under the annual gift tax exclusion:

1. The minor must receive outright ownership by age 21; and
2. If the minor dies before age 21, any remaining property must go into the minor's estate or, if there is a will, to the minor's beneficiary(ies).

Give, But Be Cautious

Although you may feel the need to reduce the value of your estate before death, you should always carefully plan out any gifts. After all, you don't want to give away so much of your estate that you can no longer take care of yourself. However, if a complete valuation of your estate confirms that you're sitting on a large estate, gift-giving before your death may make sense.

Talk to an Attorney About How to Reduce Estate Taxes by Giving Gifts

The ability to gift assets is essential in any tax savings strategy involving large estates. However, before you start writing checks or dividing up property, it's critical to obtain advice from professionals, including your financial advisor, tax professional, and estate planning attorney. After all, tax laws and gift exclusion limits can change every year. If you need legal advice, get your questions answered today by reaching out to a qualified estate planning attorney in your area.