The Three Ways To Make Tax-Free Gifts And Why You Should Use Them SoonBob CarlsonSenior ContributorOpinions expressed by Forbes Contributors are their own.I research/write about all facets of retirement/retirement planning.Nov 13, 2021,08:45am EST|
Theres been a lot of talk in Congress about slashing the lifetime exemption for estate and gift taxes (currently $11.7 million per person), perhaps reducing it by half or even more. Even if Congress does nothing now, the exemption is scheduled to be cut in half after 2025, unless Congress agrees to keep that from happening.
Because of the higher probability the lifetime exemption might be reduced, estate planners are encouraging many people to consider reducing the value of their estates by making tax-free gifts of assets while they can to the extent the assets arent needed to ensure retirement security. Holding the assets might cause them to be subject to federal estate taxes in the future, reducing the after-tax amount available to loved ones.
The tax code provides three ways to make tax-free gifts. Increase your familys after-tax wealth by using these methods to the extent they fit your estate and family situation.
The first tax-free giving method is the annual gift tax exclusion. In 2021, the exclusion limit is $15,000 per recipient, and it rises to $16,000 in 2022.
You can give up to $15,000 worth of money and property to any individual during the year without any estate or gift tax consequences. You can give in one transaction or a series of transactions. These gifts wont count against your lifetime estate and gift tax exclusion, and the recipient wont owe any federal taxes on the gift or gifts.MORE FROMFORBES ADVISOR
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You can make these gifts to as many people as you want during the year, with a separate $15,000 tax-free limit on the gifts to each person and no aggregate limit for you. A recipient doesnt need to have any family or other relationship with you.
If you have three children, you can give each of them $15,000, allowing you to remove $45,000 tax-free from your estate. In a married couple, each spouse has a separate $15,000 limit per recipient, or they can make joint gifts of up to $30,000 per recipient.
The main restriction on using the annual exclusion is that only gifts of present interests qualify for the exclusion. Basically, this means any gifts with strings or limits attached dont qualify for the tax-free annual exclusion. You have to give full legal title to the property.
An exception is whats known as the Crummey trust power, named after the court case that first recognized it.
A Crummey power allows a trust beneficiary to withdraw a gift from a trust within a certain period after the gift is made. The period usually is at least 30 days. If the beneficiary doesnt request a distribution, the money stays in the trust and is managed and distributed under the terms of the trust.
Some in Congress want to eliminate the Crummey gift, but it can be used for now.
Education and medical gifts are the second method of tax-free giving. Theres no limit on the amount of tax-free gifts that can be made for qualified education or medical purposes.
To be tax-free, education gifts must pay for direct tuition costs and not for items such as books, supplies, board, lodging, or other fees. The gifts must be made directly to an education institution, not as reimbursements to the student or parents.
The gifts can be made on behalf of any individual, regardless of his or her relationship to you, and for any level of education.
Medical gifts also must be made directly to the medical care provider to qualify for the unlimited gift tax exclusion. Payments for any items that would qualify as deductible itemized medical expenses on an individual income tax return qualify for tax-free medical gifts.
Once the annual exclusion and tax-free medical and education gifts are exhausted, you can make additional tax-free gifts using the lifetime estate and gift tax exemption.
The lifetime exemption amount in 2021 is $11.7 million and will be $12.06 million in 2022. In a married couple, each spouse has a separate exemption.
Any gifts you make during life that exceed the annual exclusion and dont qualify as tax-free medical and education gifts count against your lifetime exemption. The lifetime exemption really is set up as a tax credit. Gifts that dont qualify as tax-free under either of the first two methods are taxable gifts. You file a gift tax return and use part of your lifetime credit to eliminate the gift tax. The credit amount is set to effectively allow up to $11.7 million of lifetime gifts without owing gift taxes.
To the extent your lifetime exemption isnt used by lifetime gifts, the remainder is used to reduce estate taxes.
As youre aware, there are proposals in Congress to reduce the lifetime exemption. Even if none of these proposals is enacted, the current exemption amount is scheduled to be cut in half after 2025 when the 2017 tax law expires.
Most estate planners expect that the lifetime exemption that applies in a year a gift is made will determine whether or not it is tax free. Taxes on the estate shouldnt be increased if the lifetime exemption is lower when the estate is processed than when you made the gifts.
There are some in Congress and the IRS who want to claw back taxes on gifts made at the higher exemption amount if the exemption is lower when the estate is processed. But that idea doesnt seem to have a high probability of becoming law or being constitutional.
There are other ways to reduce taxes on gifts. These include structuring gifts so they qualify for valuation discounts and using different types of trusts, such as grantor annuity trusts. There also are proposals in Congress to limit or repeal these strategies. Individuals whose estates exceed the current exemption level also should consider making gifts and using these strategies while they still are available to reduce estate and gift taxes.Get the best of Forbesto your inbox with the latest insights from experts across the globe.Follow me onTwitter.Check outmywebsiteorsome of my other workhere.Bob Carlson
I am the editor of Retirement Watch, a monthly newsletter and web site I founded in 1990. I research and write about all the financial issues of retirement and retirement planning, for both those planning retirement and already retired. I cover estate planning, Medicare, long-term care, income taxes, IRA strategies, annuities, investments, and more. Trained as an attorney and accountant, I use independent, objective research and dont rely on rules of thumb, conventional wisdom, or biased research. I also write books. My latest book is Where's My Money: Secrets to Getting the Most out of Your Social Security and The New Rules of Retirement-Revised Edition (Wiley 2016). I also speak to groups. A believer in public service, Ive served on the Board of Trustees of the Fairfax County (Va.) Employees Retirement System (since 1992; chairman since 1995) and the Virginia Retirement System (2000-2005). Read more of my thoughts at RetirementWatch.com or follow on Twitter @RWcommunity.Read MoreRead LessEditorial StandardsCorrectionsReprints & PermissionsLoading ...