Even though it’s still early in the year, it’s never too early to start thinking about gifting. Questions that commonly crop up with gifting usually target taxes and limits. Like — Am I required to pay a tax if I give money (or property) away? How about if I receive a gift? Can I give money to my grandkids if I have already given to my child? All good questions that we can answer by reviewing a few basics.
Estate Taxes and Gift Taxes
Since estate tax is calculated by the value of assets owned at death, a billionaire couple can easily escape that tax by giving away nearly all their assets to their children or grandchildren during their lifetime. Potentially every family could give away assets at each generation, never leaving any assets for the government to tax. Uncle Sam doesn’t like this. This is why he makes sure that you pay a gift tax on assets you give away. The result is a ‘pay now or pay later’ scenario. You can either pay a gift tax now or an estate tax later. Either way you’re taxed.
If, on the other hand, you’re the lucky one receiving a gift, you are not required to pay taxes on it.
That being said, not every penny given is taxed. Uncle Sam allows you to give away a certain amount each year tax-free. For 2016, this annual exclusion amount is $14,000. This limit is for each donor and donee. That means you, as the donor, can give $14,000 to your child, Thomas (or donee), another $14,000 to your child, Emma (or donee), and another $14,000 to another child or donee. And so on. Furthermore, your spouse can do exactly the same. So between the two of you, a married couple can gift $28,000 ($14,000 times 2) to each donee.
In addition to the $14,000 annual exclusion amount just discussed, there is also a lifetime exemption amount of $5,450,000, as explained below.
Giving Beyond the Limit
What happens if you want to give away more than $14,000 this year? Let’s say, for example, you wish to gift a property worth $1,014,000 to your child. To keep the math simple, let’s assume you are single with one child.
You have two choices:
- Use the $14,000 annual exclusion and then pay a gift tax on the rest ($1,000,000).
- Use the $14,000 annual exclusion and then use your lifetime exemption for the rest ($1,000,000). (You will pay no gift tax but will use up a portion of your lifetime estate tax exemption.)
Choice #1 is simple enough. You have your free pass each year ($14,000), but anything beyond that amount requires a gift tax.
Choice #2 goes something like this. Each U.S. citizen has a federal estate tax exemption of $5,450,000 (for 2016). Effectively, this amount gets deducted from the value of your assets when calculating your estate tax. Alternatively, you can use this exemption during your lifetime to avoid a gift tax. In this example, you will have used $1,000,000 out of your $5,450,000. As a result, you will pay no gift tax. Your remaining estate tax exemption is now $4,450,000 since you used $1,000,000 of it today. The remaining exemption can go toward your estate tax or future gifts.
Remember, both the estate and gift tax limits are adjusted annually for inflation, so they may increase for 2017.
Also, to answer a common question, you don’t owe any tax when you receive gifts!
We hope this basic review is helpful as you solidify your plans for giving this year.
Note: Many states have gift and estate tax exemption amounts and tax rates that are different from the federal ones.
Originally published on November 20, 2015.
Advisory services are offered by Joslin Capital Advisors, LLC, an SEC Registered Investment Advisor.