Gifting to Children – when does the gift tax apply
In my opinion, both financial planning and estate planning focus too heavily on leaving money to children at death and overlook one of the most effective and rewarding steps – giving during life. A small gift to help with the down payment for a home, or to help a young parent take time off to be with the kids, or to help with college tuition, can often have a greater life impact than inheriting a large sum late in life. Moreover, giving during life allows parents to see the impact of their gifts. Of course, there are some tax rules to gifting, but they are not difficult. Here is what you need to know.
I will begin with a word of caution. While I encourage my clients to give to children during life, I always encourage them to first have a solid financial plan and know the impact of the gift on their own plan. One of the benefits of a financial plan is knowing what you can afford. A financial plan provides a roadmap that shows what you can spend and give with confidence.
It is also important to understand the tax rules around gifting. Small gifts are relatively straight forward since the IRS provides an annual exclusion that allows you to gift $15,000 (for 2020) per person without filing a gift tax return. The $15,000 is per person per year, so a husband and wife could gift a combined $30,000 to a child. If the child is married, then the spouse could also receive a gift of $15,000 from each parent. If there are grandchildren, then each grandchild could receive $15,000 from each grandparent. By thinking ahead and gifting creatively, these small gifts can be very effective. For example, gifting across two tax years, one in December and one in January, can effectively double the amount of the gift.
Of course, you can make gifts greater than the $15,000 annual exclusion, and a gift will not be subject to federal gift tax unless the gift exceeds the unified credit amount, currently $11,400,000. Yes, you read that correctly, $11.4 million per person is the current limit for gift and estate tax, eliminating the gift and estate tax for most Americans. This $11.4M is called the unified credit exclusion because it is the total amount that an individual may gift during life or leave in an estate without being subject to the gift or estate tax. Using some of the $11.4M through giving during life does use up some of the credit that can be used for your estate, but the current credit level is so high that most should not worry. If you exceed the $15,000 annual exclusion you will be required to file a gift tax return, but it is unlikely that a gift tax will be due.
A gift is any money or property that you give to someone without the expectation that you will be paid back. Be wary about trying to sell property to a child at a discount. The IRS could treat the bargain sale as a gift. For example, if you sell a home that is worth $400,000 to a child for $300,000 the IRS could assert that the $100,000 discount was a gift. Also, be wary of giving appreciated property. While this could be a good strategy, your basis in the property will generally transfer to the recipient as well. While no gift tax may be due, the recipient will be responsible for any capital gains tax when the asset is sold. Be sure to consult with your tax advisor before using these strategies.
Giving to your children during life is a great way to be a blessing to your family and can bring incredible joy as you see the fruit of your gifts in the lives of your children and grandchildren. If you would like to discuss ways to effectively give, please give us a call. We would be happy to help.