It may seem easy to avoid estate tax. Why not simply give away everything you own right before you die (or give it to your spouse and have him or her give it away before he or she dies)? Well, the government is one step ahead of you. There are also taxes to pay when making lifetime gifts. In fact, these taxes are part of the same tax, called the transfer tax. In essence, the government will try to tax you every time you transfer an asset to someone, no matter whether you are alive or deceased at the time.
The gift tax is a tax on the fair market value of assets transferred as gifts whether the gift is direct or indirect, and whether the gift is in trust or otherwise. Payments for support (paying for food, clothing, shelter, court-ordered child support payments, etc.) for your minor children for which you are legally obligated are not considered gifts. For lifetime transfers (i.e., gifts), there is an applicable credit amount which allows you to transfer a certain amount of assets during your lifetime free of gift tax. The amount of assets you can transfer is known as the applicable gift tax exclusion amount and is $11,580,000 in 2020 ($11,400,000 in 2019). Any amount gifted above this amount will be subject to current gift tax. There are also gift tax exclusions, such as direct payments to a health care provider for medical services on behalf of a donne. The gift tax rates are the same as the estate tax rates.
After 2010, the gift tax and estate and GST tax exclusion are the same, currently at $11,580,000 in 2020 ($11,400,000 in 2019).
IMPORTANT NOTE: The IRS uses a very broad definition of a gift for tax purposes. If you sell an asset to someone below fair market value, forgive a loan, fail to charge interest on a loan or give someone an interest in an asset you own, you have made a gift if you did so for a non-business reason. Before making a transfer of this nature, call your tax professional.
You first use your applicable credit to offset tax on taxable gifts. However, certain taxable gifts are added back to your taxable estate and thus impact the estate tax calculation. Consult with a tax professional regarding the impact on your estate tax if you have made taxable gifts during your lifetime.
Gift Tax Exclusions
There are four very important exclusions to the gift tax that allow you to make tax-free lifetime transfers without ever using your gift tax applicable credit amount. By doing so, your estate is reduced when you die, and your family ends up with cumulatively more assets. Whenever you save estate taxes, you are giving more to your family or to other parties and less to the government.
Gifts to Charities
You are generally allowed to give an unlimited amount to qualified charities and not incur any gift tax or estate tax on those transfers.
Gifts to a Spouse
You can give an unlimited amount of gifts each year to your spouse free of gift tax. Special limits apply if your spouse is not a U.S. citizen.
IMPORTANT NOTE: If you plan to give your spouse a gift using a trust, or if his or her right to use the gifted property will terminate upon a specific event or at a specific time, you may not get an exemption from gift tax. Speak to your attorney or other estate planning professional about this before you actually transfer the property into the trust.
Gifts for Medical Or Educational Expenses
You can give an unlimited amount to pay someone's medical or educational expenses. These transfers must be made directly to the institution and not to the beneficiary. In the case of educational expenses, only payments for tuition are covered for this exemption (payment for books or room and board is not covered). Medical expenses that are reimbursed by insurance are not eligible for this exemption.
2020 Annual Exclusion Gifts
In 2020, every person is allowed to give any individual up to $15,000 a year (same as in 2019) in gifts (indexed for inflation). This is called your Annual Exclusion. In 2020 you can give $15,000 to one hundred different people each year and have all the gifts covered under this exclusion. You are not allowed to carry over an annual exclusion from one year to the next. Example: You and your spouse cannot give your sister $30,000 this year and claim a full annual exclusion because you did not give your sister anything last year.
IMPORTANT NOTE: Gifts that qualify for the annual exclusion must be "present interest" gifts versus gifts of a "future interest". This means the recipient must be able to use the assets immediately, versus restricting their "present use", for example, by putting the assets in a trust for future transfer. However, there are methods of qualifying gifts in trust for the annual exclusion, e.g., a section 2503(b) trust established for a minor and adding trust provisions that give beneficiaries certain withdrawal rights. Ask your estate planning professional for a more detailed explanation of these methods.
If you are married and neither of you are nonresident aliens, you can file an election on your gift tax return that allows both you and your spouse to treat gifts made by one spouse as having been made equally by each of you. This is called gift splitting.
For example, if in 2020 you gave your brother $30,000, and your wife didn't give him anything, you can elect gift splitting and the entire gift is covered by the annual exclusion ($15,000 from you and $15,000 from your spouse).
Gifts and Taxes
Gift Tax Result:
You gave your sister $30,000—You can gift split with your spouse and you would be viewed as each giving $15,000.
No gift tax, since each gift is equal to or less than $15,000.
Your spouse gave her mother $16,000—You can split the gift with your spouse. Your gift would be viewed as each giving $8,000.
You gave the March of Dimes $16,000.
No gift tax since the March of Dimes is a qualified charity. You may also get an income tax deduction for this gift.
Your spouse paid $25,000 directly to a hospital for her brother's heart surgery.
No gift tax since it was a direct payment for medical expenses.
You gave your spouse a $26,000 car for Christmas.
No gift tax because of the unlimited marital deduction.
When Do You Have To File Gift Tax Returns?
Gift tax returns are filed on Form 709 and are due by April 15 following the year you made the gift. In general, you need to file a gift tax return when you:
If you want to elect gift splitting, file your returns before the IRS audits you, or you do not get the right to claim this benefit.
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