Understanding the Tax Consequences of Making Gifts

By Liza Hanks
Finch Montgomery Wright

Gifting can be an invaluable component of your estate planning strategy. Gifting annually to family members enables you to reduce estate taxes by reducing the size of your overall estate and moving appreciating assets out of your estate early. It is also a way to help out your children while you can see the benefits of that help (and hear their appreciation.) However, gifting can have tax consequences, as well as practical repercussions, so it’s important for you to understand gifting rules and how to properly strategize your gifting strategy into an integrated estate plan.

Gifting Reduces Estate Taxes

Obviously, if you give away an asset, it is no longer part of your taxable estate. A smaller estate will have lower estate tax liability, cost less to probate, and reduce complexity after a death. Less obviously, lifetime gifting can also be satisfying, since, as I often tell my clients, they'll be around to hear a 'thank-you' and be able to see the difference that their gifts can make in the lives of their loved ones.

Gifting can also be a strategic way to move rapidly appreciating assets out of an estate in a tax-efficient way. But because the current gift and estate tax law is integrated, lifetime gifts have an impact on gifts at death, for both estate and income taxes.

The Annual Gift Exclusion v. The Lifetime Exclusion

Each year, you can currently give up to $14,000 away to any one beneficiary, free of gift tax. This is called the annual gift tax exclusion. The IRS occasionally increases this number, but in 2016 it remains at $14,000. Married couples can agree to split gifts, and so can gift up to $28,000 per year per beneficiary. These limits apply to the gift made to each beneficiary (called a 'donee' in lawyer talk). I tell my clients that, if they wanted to, they could give an annual exclusion gift to every single person in Cleveland (and it would be much appreciated I'm sure). As long as all annual gifts fall below the threshold, none of the gifts need to be reported on a gift tax return by April 15 of the following year. If any one gift does exceed that threshold, however, then all of the gifts must be reported on that return.

These annual gifts, provided they fall below the threshold, do not reduce the donor's lifetime gift and estate tax exclusion. You can think of annual gifts like a coupon book for gifts made each year. Gifts that exceed the threshold, and that therefore need to be reported, do reduce this lifetime exclusion. But here's the amazing news: you can currently give up to $5.45 million away, during life or at death, without having to pay any gift or estate tax. I tell my clients to think of the lifetime exclusion like a basketball clock--any lifetime gifts that exceed the annual exclusion need to be reported, but as a result of the gift, they won't owe any gift tax, their clock will just have run down some time.

For example, if a client decides to give a child $300,000 towards the purchase of a house in 2015, they will report a gift of $286,000 ($300,000 - $14,000 annual exclusion), but owe no gift tax on the transfer. They will still have $5,144,000 worth of gift and estate tax exclusion left, assuming they had made no prior reported gifts. I realize that we live in a wealthy area, but many of my clients are not likely to use up their exclusion, either during life or after death, and should consider making lifetime gifts if that would be of benefit to their loved ones. Finally, if you want to amend your estate plan to take such lifetime gifts into account after death, that's easy to do. In effect, that child just received a part of their inheritance early, when it made a substantial difference in their lives.

Considering Gifts

Gifting isn’t a consequence-free estate planning strategy. First, of course, you can't give away assets that you may need in the future. Second, you shouldn't give away assets that you want to retain control over, such as stock or vacation homes. Third, gifting an interest in a house, which some of my clients think of as a good idea, puts a parent's assets at risk of a child's creditors, never a good idea.

Basis: The Big Consideration

And very importantly, gifts made during life carry the donor's basis. Clients often don't realize this. For example, if a generous mother would like to give appreciated stock away during her lifetime, her children will receive that stock with the mother's basis: ten shares of Great Company, purchased for $5/share in 1963 and now worth $50/share, will generate significant capital gains when the children sell that stock. If, instead, Mom gives that stock to the kids at death, they will inherit it at the date of death value, and owe no capital gains if they sell it at that value.

Ultimately, gifting is a valuable tool to help you reduce the size of your estate and to ensure that your heirs benefit from your legacy when they need it most. If you are considering making lifetime gifts as part of your estate plan, feel free to contact me at lhanks@fmwlaw.com or call me at 650/327-0088. You can also download my book, The Family's Guide to Wills and Estate Planning, for free.