Amassing wealth comes with many benefits, but having a substantial estate comes with the repercussions of elevated taxes. Gifting portions of your assets to mitigate tax ramifications is possibly a reasonable strategy to help ensure you optimize your estate’s potential. By employing tax and financial planning strategies, you can maximize gifts to your loved ones and beneficiaries, all while reducing tax consequences.
What constitutes a gift?
Gifts that qualify for the gift tax are any contributions (quantified in money or value) made to an individual that is unequal to funds received in return. In other words, you are gifting the amount to a chosen individual without expecting payment back. There are certain gifts excluded from the gift tax. Amounts under the exclusion threshold, educational accounts and payments, medical aid, gifts to your spouse, gifts given to qualifying charities and political donations do not apply.
What are some tax advantageous strategies to consider?
The most straight forward strategy is setting up reoccurring annual gifts to loved ones. For 2021, annual gift tax exclusions are $15,000, regardless of relation to the recipient or quantity of recipients. Annual gifting of $15,000 (in 2021) may not seem like much, but it quickly adds up. You and your spouse may each contribute that amount to individuals, and many enjoy being able to help the recipients while they are alive, rather than simply after passing.
Educational accounts, namely 529s, have the same contribution limitations as annual gift tax exemptions. A married couple can contribute $30,000 (in 2021) to an individual’s 529 annually, and each state has a set lifetime contribution limit. 529 plans specifically can allow you to give five years’ worth of gifts at once ($150K per couple), frontloading the benefit into a tax-exempt vehicle. One caution must be considered with 529s: the funds return to the estate upon the benefactor's death if they were gifted within the previous five years.
GRATs (Grantor Retained Annuity Trusts) are another opportunity to minimize tax burdens on large estates that wish to freeze portions of their estate’s current value and shift the appreciation of those assets to their beneficiaries without generating gift taxes. GRATs are attractive if a few uncontrollable variables work in the grantor’s favor (low interest rates, positive growth rates and lifespan), so a thorough discussion is required to examine if GRATs make sense for you. Please visit our article on GRATs to learn more about these types of trusts and the tax benefits they offer.
Who is responsible for the gift tax, and may I deduct these gifts from my income tax?
Gifts beyond the annual limit of $15,000 will reduce your lifetime annual exemption (currently at $11.7 million). However, it is important to note that gifting to individuals (non-charities) are not tax deductible. Please refer to IRS Publication 559, Survivors, Executors, and Administrators to decipher whether your gifts apply to your lifetime exemption or your annual exemption. This informative article can guide you through the many different aspects of distributing a final estate, including how taxes impact the process, and will help you understand the importance of the gift tax strategies we are discussing.
With the current lifetime exemption of $11.7 million due to expire at the end of 2025, or sooner if Congress makes a change, both the annual exemption and the lifetime exemption will impact a far larger portion of the population. Now is a great time to speak with an estate planning attorney and financial planner to prepare and strategize around these various structures.
Source: Internal Revenue Service
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