As we begin the fourth quarter of the calendar year, ‘tis the Season for Giving, and this is a common question that the attorneys at Drobny Law Offices, Inc. receive, but especially this time of year. In typical lawyerly fashion, the answer always is: “it depends.”
For 2019 the yearly limit on how much an individual may gift to another without having to worry about gift tax is $15,000 per recipient. This figure is known as the annual exclusion amount. Spouses can combine their annual exclusions to double the size of the gift. For example, a married couple with three adult children could make a joint cash gift of $30,000 to each adult child (total gifts in the amount of $90,000). None of these gifts exceed the annual exclusion amount so there is no worry about gift tax or the filing of a gift tax return.
Gifts that exceed the $15,000 annual exclusion amount (or $30,000 for a married couple) are referred to as taxable gifts, which is a misnomer, because there aren’t actually any gift taxes owed until the donor has made more than $11.4 million in taxable gifts. Taxable gifts only reduce the donor’s lifetime gift exclusion amount, which is currently $11.4 million. The balance remaining on a donor’s lifetime exclusion amount upon his or her death is the amount that will pass free from Federal Estate Taxes.
This is where confusion typically lies. Many people believe that once they exceed the annual exclusion amount, they owe gift tax to the IRS. You do not owe any gift tax to the IRS until you have exhausted your $11.4 million lifetime gift exclusion. So unless you have previously made significant gifts, odds are that no gift tax is owed.
Nevertheless, gifts that exceed the annual exclusion amount (taxable gifts) are required to
be documented with the filing of a Gift Tax Return (Form 709). This is the IRS’ way of tracking the amount of your taxable gifts during your lifetime and the balance of your Exemption Equivalent remaining at death. This is best explained through the use of an example.
Assume that a taxpayer gives her son and daughter $100,000, each, in 2019. From above, we have learned that this will trigger the requirement that the taxpayer file a gift tax return. The gift tax return will indicate that taxpayer used her annual exclusion of $15,000 for each gift. Therefore, the taxable gift on the Gift Tax Return will be reported as $170,000 ($89,000 each). This will reduce the taxpayer’s lifetime gift exclusion from $11.4 million to $11,230,000. So unless the taxpayer previously gifted over $11,230,000 during her lifetime, her 2019 Gift Tax Return Form 709 will show taxes owed in the amount of $0.
While generosity with family members often occurs under the radar, the law is clear: if the gift exceeds the annual exclusion amount, a Gift Tax Return must be filed. There are of course exceptions to every rule. Gifts that neither decrease a taxpayer’s lifetime gift exclusion nor reduce a taxpayer’s lifetime gift exclusion amount include those gifts of tuition payment (provided they are paid directly to the school) and medical payments made for another’s benefit (if paid directly to the medical service provider).
As noted above, the above-referenced taxable gifts reduce your lifetime federal estate tax exclusion amount. The federal estate tax exclusion amount (commonly referred to as the amount an individual can leave tax free upon their death) is also currently $11.4 million per person ($22.36 million for a married couple). Generally speaking, this means that the IRS will either allow you give away $11.4 million while you are alive, $11.4 million when you die, or any combination of the two totaling $11.4 million. So in the above example, when the taxpayer passes away, only the first $11,230,000 from her estate will be able to pass free from estate tax.
There are potential and significant adverse capital gains tax effects of gifting real property and/or other appreciated assets , most notably, step up in basis. Specifically, the cost basis in assets gifted carries over to the donee, while the cost basis of appreciated assets is stepped-up to the date of death value. For example, if taxpayer paid $100,000 for a rental property and gifted to her daughter, who immediately sold it for $280,000, Mom’s cost basis of $100,000 would carry over to daughter, who would have a $180,000 capital gain. If Mom had kept the property until she died, her cost basis would have received a step-up in basis to the date of death value of $280,000, washing away all capital gains. Daughter could have then sold it and paid zero capital gains taxes.
If a taxpayer’s total estate is going to be less than $11.4 million (or $22.8 million for a married couple), there may be no estate/gift tax reasons to make lifetime gifts, since there won’t be any Federal Estate Taxes at death. Gifted property results in the donor’s cost basis carrying over to the donee, while inherited property receives a step up in basis to the date of death value. Therefore, there is a potentially huge tax advantage to holding onto property until you die: no gift tax/no Federal Estate Tax/no capital gains tax to your heirs.
Drobny Law Offices, Inc. recommends that you contact our office or your CPA prior to effectuating any gifting plan. Should you have any questions regarding this article, please feel free to contact this office.