Gift giving made easy - Annual exclusion reduces your taxable estate

Adler Pollock & Sheehan P.C.
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Adler Pollock & Sheehan P.C.

How can you reduce the size of your taxable estate? There are many ways to accomplish this objective, including the use of irrevocable trusts and other sophisticated estate planning techniques. But one of the most effective methods is also the simplest: leveraging your annual gift tax exclusion. Using this technique can cut down your estate to a manageable size without paying any federal gift tax.

Annual exclusion primer

Using the annual gift tax exclusion, you can give to an unlimited number of family or friends cash or property valued up to a specified amount each year without owing any gift tax — so long as the gifts are considered to be “present interest” gifts. In general, a present interest gift is one in which the beneficiary has an unrestricted right to immediately use and enjoy the property. If you repeat the gifting strategy over several years, you’ll see your taxable estate dwindle, while still keeping the assets within the family. 

The annual gift tax exclusion, which is stated as $10,000 in the tax code and is subject to inflation indexing, currently is $14,000 per recipient. In other words, you can give each recipient gifts of cash or property valued up to $14,000 each year with no gift tax consequences. The exclusion may be increased only in increments of $1,000, so it changes infrequently. The last time it was increased, from $13,000 to $14,000, was back in 2013.

Let’s suppose you have three adult children and seven grandchildren. If you give each one of them $14,000 in 2016, for a total outlay of $140,000 (10 × $14,000), you’ll have reduced your estate by that amount without paying federal gift tax. If you continue this strategy for five consecutive years, you will have handed out $700,000 (5 × $140,000) completely free of gift tax. You don’t even have to file any gift tax returns!

What’s more, if you’re married, you and your spouse can give away a combined gift of up to $28,000 a year — via split gifts — without any gift tax. Assuming you follow the same pattern of gifting all 10 family members for five years, you will have whittled down your estate by $1.4 million ($28,000 × 10 × 5).

Of course, by giving away cash or property, you’re relinquishing full control over those assets. Once they’re out of your hands, they’re technically gone forever. However, if this was your ultimate goal anyway, the annual gift tax exclusion can certainly provide the means with little fuss.

Giving assets that appreciate in value

The rules are a little trickier if you’re gifting assets such as securities. Generally, the value of property for gift tax purposes is its fair market value. If you gift property that’s appreciated in value, the recipient must use your basis (usually, the original cost) to compute the taxable gain if he or she subsequently sells the property. Nevertheless, the gain will be taxed to the recipient, who’ll likely be in a lower tax bracket than you. Thus, gifting can result in income tax savings for the family as well.

In addition, be aware that gifts made directly to a financial institution to pay for tuition or to a health care provider for medical expenses on behalf of someone else don’t count toward the gift tax exclusion, and, in fact, aren’t even reportable gifts. You can pay tuition in excess of the annual exclusion amount of $14,000, and, in the absence of other gifts that may be reportable, you won’t have to file a gift tax return.

Finally, you have one other gift tax break in your hip pocket: the lifetime gift tax exemption. This exemption applies to gifts of up to $5 million, indexed to $5.45 million in 2016, after you’ve exceeded the annual gift tax exclusion. But using any part of this exemption erodes the available tax shelter from estate tax, so you might decide to limit your lifetime gift giving to amounts covered by the annual gift tax exclusion.

Talk to your advisor

Even though using the $14,000 per recipient annual exclusion is a simple way of reducing your taxable estate, this is not to say you should abandon other more sophisticated estate planning techniques designed to maximize the benefits of the $5.45 million gift and estate tax exemption. Consult with your advisor before the end of the year to determine the best plan of action for your situation.

Sidebar: ’Tis the season to give

Gift-giving strategies based on the $14,000 annual gift tax exclusion are often implemented around the traditional holiday season. For instance, you might arrange to give three recipients $14,000 each in December and then give the same three recipients another $14,000 each in January. This reduces the size of your estate by $84,000 (3 × $14,000 × 2) in just two calendar months.

Of course, you shouldn’t make such gifts in a complete vacuum. Coordinate your lifetime gifts with other aspects of your estate plan.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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