Nora Tellifson, CPA •
The holidays are approaching, and who doesn’t appreciate the gift of cash? I find that there’s a lot of confusion out there surrounding personal gifting so let’s demystify that because it’s very powerful, and you can do a lot without incurring any reporting requirements. I am not referring to charitable contributions here which are amounts you give to a charitable organization and may be deductible for income tax purposes. A personal gift occurs whenever you give something personally to someone (a family member or friend usually) and do not receive something back in consideration. For purposes of our discussion, I am going to stick to personal gifts of cash. Just be aware that there are gift considerations when you gift noncash items also.
The holidays are approaching, and who doesn’t appreciate the gift of cash? I find that there’s a lot of confusion out there surrounding personal gifting so let’s demystify that because it’s very powerful, and you can do a lot without incurring any reporting requirements. I am not referring to charitable contributions here which are amounts you give to a charitable organization and may be deductible for income tax purposes. A personal gift occurs whenever you give something personally to someone (a family member or friend usually) and do not receive something back in consideration. For purposes of our discussion, I am going to stick to personal gifts of cash. Just be aware that there are gift considerations when you gift noncash items also.
The most important thing to know here is that you can give to as many people as you want up to the annual gift exclusion amount every year without incurring any gift tax filing requirement. The annual exclusion amount for 2016 is $14,000, and it remains the same for 2017. In practical terms, this means that you can give 1,000 of your closest friends $14,000 each and have no gift tax filing requirement. If you have a spouse, you and your spouse can give 1,000 of your closest friends $28,000 each and have no gift taxes due (although in this case there may be a filing requirement). If you have more than 1,000 close friends, you can do the same for them.
What happens if you give someone more than that annual exclusion amount? In that case, you would have to file a gift tax return but would not owe any taxes, in all likelihood. As it stands in 2016, there is a lifetime gift tax exemption of $5.45 million. So if you gave your grandson $20,000 in 2016, which is $6,000 over the annual exclusion amount ($20,000-$14,000=$6,000), you would have to file a gift tax return showing that you have chipped away at your lifetime gift exemption amount and now have only $5,444,000 ($5,450,000-$6,000=$5,444,000) left on your lifetime exemption amount to give away before you will be required to pay gift taxes! That’s still a whole lot of money before you incur any gift tax liability.
Confusion abounds regarding income taxes related to cash gifts. Here is the deal: as long as it is below the annual exclusion amount, no one is paying tax when the cash gift is given. The recipient does not pay income tax upon receipt of the cash gift, no matter how large the gift is. If the recipient invests the cash, he or she will eventually pay tax on investment earnings in the future, just as they would for any investment, but at the time of receiving the gift, there are no tax implications for the recipient.
Back to our discussion of giving away up to $14,000 a year per person, why would you want to do this? One reason is that if your total estate is expected to be greater than $5.45 million. When you die, the amount of your estate over $5.45 million will be subject to gift and estate tax. If you incrementally reduce your estate below that threshold by giving away annual gifts up to the exclusion amount, you reduce the value of your estate, and conceivably, none of the annual gifts or the remainder of your estate will ever be subject to gift and estate tax. Realize that the total value of your estate may include real estate. If you have property in a high cost area, you can reach that $5.45 million a lot faster than you might think.
Another reason for giving annual gifts, rather than saving it all for an inheritance, is that the gift giver has the pleasure of being alive to see the recipients benefit from their gift. In other circumstances, the gift giver may be concerned that the recipient would blow a large inheritance all at once. For instance, the heir may feel that the best use of a large inheritance is a tricked out Lamborghini! The gift giver has more control over the impulses of the recipient if gifts under the annual exclusion amount are doled out over time rather than inheriting it all at once.
Monetary gifts to minor children can be an effective way of shifting income to a lower tax bracket, but there are some pitfalls to watch out for. In the case of grandparents gifting to grandchildren and the money being invested, once the children’s income gets over a certain threshold, it will be taxed at the parents’ income tax level. This is referred to as “kiddie tax”. As long as the parents’ tax rate is lower than the grandparents’ tax rate, this remains a beneficial example of income shifting that results in a lower overall tax burden. However, if the parents’ tax bracket is higher than the grandparents’ tax bracket, then we have shifted the income to a higher tax rate which is generally not desirable.
One gift to children that is excluded from “kiddie tax” considerations is contributions to a 529 college savings plan. Money that is earned inside the 529 plan is not taxed as long as it’s used for qualified educational purposes. Married grandparents could gift $28,000 a year to a 529 plan for each grandchild. You may also “superfund” a 529 plan whereby a giver can contribute 5 years’ worth of the annual exclusion amount or $70,000 (5x$14,000) to a 529 plan. You will have used up your annual exclusion amount for that child for those 5 years, but the objective is to front load the 529 plan so that more earnings can accumulate. There may be some limitations depending on the state, but you can generally “superfund” a 529 plan with up to $140,000 in a year. Qualified transfers for tuition and medical care can also be made in any amount, are not subject to annual gift exclusions amounts, and can be made on anyone’s behalf (no family relationship is required). The critical element with those qualified transfers is that payment must be made directly to the medical provider or the educational institution.
You can see that there many ways to gift money without invoking gift tax or even a gift tax filing requirement. If you are in the position to gift money, strategic, planned gifting can make a big impact on the recipients of your gifts and might even decrease your income tax burden in the process. We have only covered some simple approaches here. As always, I recommend you consult your accounting professional if you would like to embark on a strategic gifting plan.
What happens if you give someone more than that annual exclusion amount? In that case, you would have to file a gift tax return but would not owe any taxes, in all likelihood. As it stands in 2016, there is a lifetime gift tax exemption of $5.45 million. So if you gave your grandson $20,000 in 2016, which is $6,000 over the annual exclusion amount ($20,000-$14,000=$6,000), you would have to file a gift tax return showing that you have chipped away at your lifetime gift exemption amount and now have only $5,444,000 ($5,450,000-$6,000=$5,444,000) left on your lifetime exemption amount to give away before you will be required to pay gift taxes! That’s still a whole lot of money before you incur any gift tax liability.
Confusion abounds regarding income taxes related to cash gifts. Here is the deal: as long as it is below the annual exclusion amount, no one is paying tax when the cash gift is given. The recipient does not pay income tax upon receipt of the cash gift, no matter how large the gift is. If the recipient invests the cash, he or she will eventually pay tax on investment earnings in the future, just as they would for any investment, but at the time of receiving the gift, there are no tax implications for the recipient.
Back to our discussion of giving away up to $14,000 a year per person, why would you want to do this? One reason is that if your total estate is expected to be greater than $5.45 million. When you die, the amount of your estate over $5.45 million will be subject to gift and estate tax. If you incrementally reduce your estate below that threshold by giving away annual gifts up to the exclusion amount, you reduce the value of your estate, and conceivably, none of the annual gifts or the remainder of your estate will ever be subject to gift and estate tax. Realize that the total value of your estate may include real estate. If you have property in a high cost area, you can reach that $5.45 million a lot faster than you might think.
Another reason for giving annual gifts, rather than saving it all for an inheritance, is that the gift giver has the pleasure of being alive to see the recipients benefit from their gift. In other circumstances, the gift giver may be concerned that the recipient would blow a large inheritance all at once. For instance, the heir may feel that the best use of a large inheritance is a tricked out Lamborghini! The gift giver has more control over the impulses of the recipient if gifts under the annual exclusion amount are doled out over time rather than inheriting it all at once.
Monetary gifts to minor children can be an effective way of shifting income to a lower tax bracket, but there are some pitfalls to watch out for. In the case of grandparents gifting to grandchildren and the money being invested, once the children’s income gets over a certain threshold, it will be taxed at the parents’ income tax level. This is referred to as “kiddie tax”. As long as the parents’ tax rate is lower than the grandparents’ tax rate, this remains a beneficial example of income shifting that results in a lower overall tax burden. However, if the parents’ tax bracket is higher than the grandparents’ tax bracket, then we have shifted the income to a higher tax rate which is generally not desirable.
One gift to children that is excluded from “kiddie tax” considerations is contributions to a 529 college savings plan. Money that is earned inside the 529 plan is not taxed as long as it’s used for qualified educational purposes. Married grandparents could gift $28,000 a year to a 529 plan for each grandchild. You may also “superfund” a 529 plan whereby a giver can contribute 5 years’ worth of the annual exclusion amount or $70,000 (5x$14,000) to a 529 plan. You will have used up your annual exclusion amount for that child for those 5 years, but the objective is to front load the 529 plan so that more earnings can accumulate. There may be some limitations depending on the state, but you can generally “superfund” a 529 plan with up to $140,000 in a year. Qualified transfers for tuition and medical care can also be made in any amount, are not subject to annual gift exclusions amounts, and can be made on anyone’s behalf (no family relationship is required). The critical element with those qualified transfers is that payment must be made directly to the medical provider or the educational institution.
You can see that there many ways to gift money without invoking gift tax or even a gift tax filing requirement. If you are in the position to gift money, strategic, planned gifting can make a big impact on the recipients of your gifts and might even decrease your income tax burden in the process. We have only covered some simple approaches here. As always, I recommend you consult your accounting professional if you would like to embark on a strategic gifting plan.
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