When we discuss year-end gifts, we don’t mean the tie you give to Uncle Al or the toys you give to your nephews and nieces as holiday presents. We’re talking about significant gifts, such as helping a child put a down payment on a home or start a business, or paying a grandchild’s college tuition or a relative’s medical expenses. Under these circumstances, making gifts to family members can help save federal gift and estate taxes and, in some situations, overall family income taxes.
Why Year End?
First, it is a natural time for gift giving. More pragmatically, it is a time when you may already have a good take on your financial standing for the year and know how much you can afford to give.
In 2005, the first $11,000 of gifts you make to an individual are excluded from federal gift tax due to the gift-tax annual exclusion. (The exclusion rises to $12,000 in 2006.) If you are married, and your spouse agrees, the first $22,000 of gifts ($24,000, in 2006) made to an individual are gift-tax-free. Plus, you can use the gift-tax annual exclusion for as many people as you want.
Example: Shirley has three children and seven grandchildren. If Shirley desires, she can make gifts of up to $11,000 to each of her children and grandchildren (a total of $110,000) without paying any federal gift tax on her gifts.
Note that the gift-tax annual exclusion is a "use-it-or-lose-it" proposition. You cannot carry over any unused exclusion to a later year.
Use of the annual exclusion can also result in federal estate-tax savings. While the estate-tax law provides an exemption from tax for assets totaling up to $1.5 million (in 2005), when you add up the value of your home, investment accounts, retirement benefits, life insurance, and other items, that $1.5 million exemption can be used up relatively quickly.
Making annual exclusion gifts helps you preserve your estate-tax exemption while still removing assets from your taxable estate. The money or other property given away plus any post-gift growth in value will not be included in your estate for estate-tax purposes. Therefore, the annual exclusion gifts and future investment appreciation on those amounts escape both gift and estate taxation.
Example: Going back to Shirley, assume she gives the full $110,000 to her children and grandchildren in 2005. Over the next five years, that money is invested and grows to $200,000. If Shirley then dies, the full $200,000 is excluded from her estate for tax purposes.
In some situations, gifts can save overall family income taxes. By making a gift of income-producing assets to a family member, you can "shift" income from your high income-tax bracket to the recipient’s lower bracket. If the recipient is a child under 14, however, be careful of the "kiddie tax." Generally, with the kiddie tax, at least some of the investment income of a child under age 14 is taxed at the parent’s marginal tax rate, not the child’s. Check with us for more information.
Gifts of appreciated capital gains property can also result in significant tax reductions.
Example: Mary and Jake own stock worth $22,000 that has appreciated significantly over the years they’ve owned it. If Mary and Jake sold the stock today, they would pay a long-term capital gains tax of 15% on their $15,000 gain (i.e., $2,250 in tax). But, if they give their college-bound child the stock and then have the child sell it and use the proceeds for tuition, Mary and Jake gain significant tax benefits. The gift of the stock qualifies for the gift-tax annual exclusion, if they "split" the gift. The gain on the sale of the stock is taxed to the child at her 5% rate (i.e., $750 in tax), not at Mary and Jake’s 15% rate. Thus, the net proceeds of the sale are $1,500 greater, providing more money for tuition payments.
Tuition and Medical Gifts
Under the tax law, if you make a direct payment for another person’s tuition or medical expenses, the gift is excluded from gift taxes. So, if you pay your grandchild’s college tuition directly to the college on the student’s behalf, that amount will not be a taxable gift, even if it exceeds the annual exclusion amount. Similarly, if you pay an elderly parent’s medical expenses directly to the medical care provider, the payment is not subject to gift tax.
Be aware, though, that gifts made to a qualified tuition program (a "Section 529 plan") or to a Coverdell Education Savings Account do not qualify for the tuition exclusion. But such gifts could qualify for the gift-tax annual exclusion and, under the tax law, you would be allowed to elect to spread the contributions made in a single year over five years for annual exclusion purposes.
If you are thinking about making year-end gifts, now is the time to act. If you would like additional information about the benefits of an annual gift-giving program as part of your estate- or income-tax planning, come talk to us. We’d be pleased to tell you more.