Making gifts during your life can provide you with tax savings and more.
NOTE: The federal gift and estate tax is being phased out, but its ultimate fate is still a hot political question.
While the estate tax is still in effect -- or if Congress resurrects it after it goes away as scheduled in 2010 -- you may want to take steps to reduce possible estate tax liability at your death. One way to avoid estate tax is to give away property during your life. This provides you with more than just tax savings; you also get to see the recipients enjoy your gifts.
Currently, you can make an unlimited number of $12,000 gifts of cash or other property each year, completely tax-free. To ensure these tax savings, you need remember only that no individual recipient can receive more than $12,000 in a calendar year. If you left the same gifts at your death and they were subject to estate tax, the recipients would see their gifts shrink by at least 39%.
The $12,000 annual tax exemption rule (called the "annual exclusion") is pretty straightforward. For instance, if you give $25,000 to someone, $12,000 of it is exempt from gift tax. The remaining $13,000 is not. A few more examples:
The exclusion amount is indexed for inflation; it rises, in $1,000 increments, as the cost of living does.
Couples can combine their annual exclusions, meaning that they can give away $24,000 worth of property tax-free, per year, per recipient. In fact, even if only one spouse makes a gift, it's considered to have been made by both spouses if they both consent. (IRC § 2513.) If you and your spouse give to another couple, you can transfer up to $48,000 tax-free each year.
All gifts you make to your spouse are tax-free, as long as he or she is a U.S. citizen. If your spouse isn't a citizen, the limit on tax-free gifts is currently $120,000 per year. (Internal Revenue Code § 2523(a).) However, there's seldom a reason to make large gifts to your spouse. If you each own about the same amount of property, you could worsen your tax situation by saddling your spouse with an estate that's so large it will be taxed at his or her death.
Using the annual exclusion repeatedly over a number of years can greatly reduce the size of your estate -- and your ultimate estate tax bill. Let's say you give $7,000 each to your two children, three years in a row; none of this $42,000 is subject to gift tax. Nor would it be subject to any eventual estate tax when you die. If you give $10,000 per year to one person for five years, you've given away $50,000 tax-free. (If you gave the same $50,000 to the same person in one year, you would get only one $12,000 exemption; $38,000 would be subject to tax.)
To make the most of the annual exemption, keep in mind that it is based on a calendar year. If you miss a year, you can't go back and claim that year's exemption amount. But if you spread a large gift over two or more years, you may escape gift tax complications. For instance, if you give your daughter $20,000 on December 17, $8,000 of it is taxable. You'll have to file a gift tax return (by April 15 of the next year), and you'll use up $8,000 of the total amount you can give away or leave free from estate tax. But if you give your daughter $10,000 in December and wait to hand over the other $10,000 until January 1, both gifts are tax-free.
Not only gifts of cash can be spread over several years. You can give away some stocks now, some next year. You can even give real estate in pieces -- physical pieces, if that's possible, or pieces (percentages) of ownership.
Giving children valuable property before they are adults raises the important question of who will manage the property for the child. If you give a large gift to a child under 18, an adult must be responsible for the money.
Fortunately, it's easy to arrange for an adult to manage the property, by setting up either:
The second way, a custodianship, is easier: You simply name an adult to serve as "custodian" of the money.
Custodianships are authorized under a law called the Uniform Transfers to Minors Act (UTMA), or the Uniform Gifts to Minors Act, one of which has been adopted by every state. All you need to do is appoint a custodian, in writing, and give the property to that person, instead of to the child directly.
The custodian must manage and use the money for the benefit of the child. When the child reaches adulthood (defined as age 21 in most states), he or she gets whatever's left.
To qualify for the annual exclusion from gift tax, a gift to a minor must satisfy these conditions:
An ambitious program of gift-giving is not for everyone. If parting with assets makes you feel vulnerable, fearful that you will someday be without money you need, don't do it. Or you may decide that your children or grandchildren are not ready yet to appreciate your generosity. But helping a 21-year-old get an education, or the head of a new family buy a house, can give you great satisfaction.
One reason that planned gift-giving has gained in popularity is that people live so much longer than they used to. If you wait until you die to transfer your wealth, the recipients -- for most people, their children -- may be nearing old age themselves. Your financial help will probably be more useful when they are younger.
Cona Elder Law is a full service law firm based in Melville, LI. Our firm concentrates in the areas of elder law, estate planning, estate administration and litigation, special needs planning and health care facility representation. We are proud to have been recognized for our innovative strategies, creative techniques and unparalleled negotiating skills unendingly driven toward our paramount objective - satisfying the needs of our clients.
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