The last couple of posts we’ve talked about giving to and investing in causes that are important to you. For the next two posts, we’re going to bring the topic of giving a little closer to home. This month, we’re going to cover giving to family.
Giving to our family, especially children or young relatives, is probably the most common personal giving topic discussed with clients. There are many reasons why we want to share wealth with our family members: to provide them a good head start, to assist with college planning or that first major purchase, or to pass along a future inheritance for enjoyment today. Whatever the reason, there are a couple of key topics to consider as you plan any year-end gifts to your love ones.
Primarily, it’s important to consider the annual gift tax exclusion amount. For 2019, this exclusion amount is $15,000 (NOTE: there is no tax on gifts to spouses). The annual exclusion amount is the amount you can give to a person without the need to notify the IRS. There are two misconceptions behind this annual exclusion. First, people believe they are limited to $15,000 total giving each year. This is not true. The annual exclusion amount is per recipient. This means if you have three children, you can give away up to $15,000 each child per year for a total of $45,000. This exclusion amount is also an individual amount. In other words, a married couple can give away a combined $30,000 per recipient per year.
The other misconception is that gifted amounts over this exclusion amount require a gift tax return to be filed and/or gift taxes to be paid. This is partially true. A gift tax return is required for gifts over the annual exclusion amount. Paying taxes however is only needed if you could potentially have an estate tax issue at the end of your life, as any lifetime gifts over the exclusion amount reduce the available exclusion amount for estate tax purposes. Due to the large $11.4 million Federal estate tax exclusion per person, this is likely not a major concern for most. So while a gift tax return is required, most choose not to pay any gift taxes.
It’s important to note that these rules apply to gifts directly given to the recipient. Payments directly to educational or medical institutions are not subject to gift taxes.
The only time gifts over the annual exclusion amount do not require a gift tax return to be filed is in the case of “super-funding” a 529 college savings plan. There is a special rule that allows a giver to utilize up to 5 years’ worth of their annual gift tax exclusion amounts for an individual ($75,000) for a one-time gift into a 529 college savings plan.
The other consideration arises when giving away property or investments. When property is given in-kind, its cost basis for tax purposes follows. This means if property was purchased many years ago for $20,000, and now is worth $200,000, when it is gifted to another individual, the taxable amount to the recipient should they choose to sell is estimated to be $180,000. This is in contrast to how inherited property is treated for tax purposes. If this same property in the example above was passed to someone as a part of inheritance, the cost basis for the recipient is the market value on the date of death. If the property is subsequently sold, the taxable gain should be minimal.
Finally, it’s important to discuss potential gifts with both your financial advisor and tax advisor to review all considerations before moving forward. There are various strategies not discussed here that may be good options for you depending on the gift and its objective.