by Mary Lago, CFP®, CTFA
Wealth Management Chair
Portfolio and Wealth Management
With the hustle and bustle of the season around us, many are considering the good cheer they can share with others.
For those of the mindset that it is better to give than receive, here are some guidelines on:
Gifts that can be completed tax-free
Those that trigger a federal gift tax
Charitable gifts that may provide a tax deduction
In general, gifts to other individuals are subject to a federal gift tax (not to be confused with income tax), and possibly a generation skipping tax, but there are numerous exceptions creating a plethora of options for tax-free gifting:
Annual exclusion: Anyone may give up to $15,000 per year to as many individuals as they like without the need to report or pay tax on the gift(s). Under this exception, spouses or partners can gift up to $30,000 per recipient and the recipient may be a minor and need not be a relative. In 2022, the annual exclusion amount will increase to $16,000 per year. There are special rules that allow “superfunding” of 529 education saving plans with up to five years of annual gifts per recipient and these gifts should be carefully coordinated with your CPA. Gifts in excess of the annual exclusion, may not trigger tax and may simply use a portion of your lifetime exemption amount as noted below.
Tuition or medical expenses: The payment of tuition or healthcare expenses directly to the provider are also exempt from gift tax. Common applications of this exception include grandparents paying tuition expenses for their grandchildren and parents covering health insurance premiums for their adult children and their families, but there are other uses too. Be careful to issue checks directly to the service provider as reimbursement to the person who paid the expense could trigger taxation.
Federal lifetime exemption amount: The federal lifetime exemption amount for gift and estate tax is the cumulative amount we can give away during our life and/or at death without incurring a federal transfer tax of 40%. For 2021, the exemption is $11.7 million per person (giver, not recipient) and will increase to $12,060,000 for 2022. One of the common questions we receive is, “What happens if I give my child more than $15,000 per year?” Assuming the gifts don’t qualify for other exceptions and that the giver has not already used their lifetime exemption, one simply works with their CPA to file a gift tax return (Form 709). This will reduce the remaining lifetime exemption available. For example, a parent gives their child $100,000 in 2021. The initial $15,000 qualifies for the annual exclusion and does not count against their lifetime exemption. The parent would file a gift tax return reporting the use of $85,000 of their lifetime exemption, reducing the $11.7 million to $11,615,000 available for future use.
Generation skipping transfer tax exemption: Similar to, but separate from, the lifetime exemption amount for gift and estate taxes is the generation skipping transfer (GST) tax exemption amount. The GST tax exemption is currently equal to the federal gift and estate tax exemption amount of $11.7 million. The GST tax exemption applies when individuals are making gifts either to grandchildren or to non-related individuals who are at least 37.5 years younger. When applicable, the GST tax of 40% is in addition to the 40% gift/estate tax so proper planning is worth the effort. The gift/estate tax exemption and GST tax exemption can be applied to the same gift or used separately, but generation skipping transfers are subject to both the gift/estate tax and the GST tax unless the appropriate exemption balances are available in each category.
Gifts to spouses: Gifts to spouses who are U.S. citizens have an unlimited exemption and are not subject to gift tax when transferred during life or estate tax at death.
Taxable Gifts
Gifts that do not qualify for one of the exceptions noted above, will be subject to a 40% federal gift tax and potentially a 40% GST tax. Gift and GST taxes are generally payable by the giver and not the recipient.
Recipients generally do not owe tax on the amount they receive. Outright gifts of cash do not incur any tax for the recipient. However, if one receives a gift of appreciated assets such as securities or real estate, there may be capital gains tax due upon the sale of the asset(s). Some of the more complex multigenerational trusts, may defer certain taxes until the time of distribution to beneficiaries so trust beneficiaries should work with the trustee and their CPA to understand any tax consequences.
Tax-Deductible Gifts
To discuss gifts that trigger a tax deduction, we will switch away from the world of gift, estate or GST taxes and into the world of income tax. While gifts to individuals do not qualify for federal tax deductions, gifts to qualified charitable organization generally do allow tax-filers to claim a charitable deduction on their income tax returns. In order to benefit from the tax deduction, the total of the charitable gifts and other deductions will need to be in excess of the standard deduction applicable to the tax filer for the year, with a relatively new exception. Cash gifts made directly to operating charities qualify for a tax deduction of up to $300 per person even for those claiming the standard deduction. Charitable deductions are also subject to limits based on the tax filer’s adjusted gross income (AGI). For contributions to public charities, gifts of cash may generally be deducted up to a maximum of 60% of one’s AGI and gifts of long-term appreciated securities may be deducted up to a maximum of 30% of AGI. For 2021, there is a special rule allowing the deduction of up to 100% of AGI for cash gifts to operating charities. Charitable gifts made in excess of these limits, can often be carried forward for an additional five years.
Finally, we noted gifts to individuals do not qualify for an income tax deduction. However, some states do provide for a state level income tax deduction, or credit, for contributions to 529 education savings plans.
We hope this guidance helps you consider your 2021 and future gifting strategies. Your Ferguson Wellman and West Bearing teams are here as a resource, but be sure to review these general concepts with your qualified tax advisors to determine how they may apply to your specific circumstances.
Ferguson Wellman and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.