Along with the recent talk of health care and income tax reform, there has been much discussion of repealing “death” taxes or estate taxes (see our earlier post regarding that topic here). We are yet to find out if there is enough political support to make that happen or how transferring wealth at death will look without it. More certain, however, is that another wealth transfer tax, the gift tax, is here to stay, primarily because the gift tax has long been considered a “backstop” for the income tax. For example, potential gift tax consequences complicate plans to transfer property to an individual in a lower income tax bracket solely to sell the property before transferring the proceeds back to the original owner.
While the estate tax is a tax on the transfer of property at death, the gift tax is a tax on the transfer of property during life. Subject to certain exceptions, a transfer of property to another individual during life is subject to gift tax when the person making the transfer (the “transferor”) does not receive adequate consideration (i.e., property having an equal value to the transferred property) in return.
A gift tax return (Form 709) is required to be filed in many cases, even when no gift tax is due. The return is generally due on April 15 following the year of the gift. When gift tax is due, it must be paid by the transferor – not the person receiving the gift – and the highest gift tax rate is equal to 40 percent of the value of the gift.
The exceptions to the gift tax are significant enough that few people ever have to file a gift tax return, and even fewer ever owe gift tax. Those exceptions are as follows:
- Marital deduction: Gifts to a U.S. citizen spouse, including outright gifts and gifts to qualifying trusts, receive a 100 percent marital deduction, meaning they are entirely exempt from gift tax.
- Charitable deduction: Gifts to qualifying charities also receive a 100 percent charitable deduction, again meaning they are entirely exempt from gift tax.
- Payments for medical care and tuition: Payments made on behalf of another individual directly to an institution or person providing medical care to that person, and payments made directly to a qualified educational institution for tuition (not room and board) for another individual are excluded from gift tax consequences.
- Annual exclusion: As of 2017, each individual can give away up to $14,000 worth of property to as many individuals desired during a single year without gift tax consequences. The “annual exclusion amount” is indexed to inflation, but it only moves in $1,000 increments. A requirement of this “annual exclusion” from gift tax is that the gift must be of a present interest in property, meaning that gifts to many trusts do not qualify for the annual exclusion. This is why beneficiaries of certain trusts, such as Irrevocable Life Insurance Trusts, are often provided “Crummey” notices, or notices of present withdrawal rights, when the donor contributions money or property to the trust. Spouses can “split” gifts, meaning that one spouse can give $28,000 to an individual, and, on a timely filed gift tax return, the spouses can elect to treat the gift as if it was made one-half by each spouse. Lastly, a donor can contribute five years’ worth of annual exclusions (currently $70,000) to a 529 account in one year and elect, on a timely filed gift tax return, to have the gift treated as if it was made in equal amounts over a five-year period.
- Lifetime exemption. As of 2017, each individual can give away up to $5,490,000 worth of property during his or her lifetime without paying gift tax. Under current law, this amount, known as the “applicable exclusion amount,” or the “exemption amount,” is also the amount that can pass at an individual’s death free of estate taxes. If the estate tax is repealed, this number may change since it is based on the current estate tax. We will watch legislation closely and will provide an update if this amount changes.
Even if your plan to transfer property to another individual such as your spouse, child, or grandchild does not fit within one of the above exceptions, our attorneys are experienced with techniques that avoid negative gift tax consequences such as installment sales and low-interest loans. Additionally, since the gift tax is based on the value of property transferred, we can discuss legal techniques to reduce, or discount, the value of property transferred in order to reduce the gift tax consequences.