Article written by Kevin O’Donnell, Esq.
Everyone likes receiving gifts but most do not associate gifting with estate planning. Many of our clients use gifting as a part of their estate plan for several reasons. By giving while you are alive, you have the luxury of seeing the recipient enjoy the gift. Furthermore, giving while you are alive permits you to place restrictions on the gift to ensure it is used in the manner you desire. But gifting can have several consequences that must be considered to ensure it is aligned with your estate planning goals.
First, gifting can have tax consequences because the United States has a Federal Gift Tax. The gift tax is a “transfer tax” which means it is levied upon the transfer of assets from the donor (the one who makes the gift) to the donee (the recipient of the gift).
Fortunately, most of us will never pay gift taxes because:
- The “Gift Tax Annual Exclusion Amount” (or GTAE for short) allows you to give away up to fifteen thousand dollars ($15,000) per donee per year without reporting the gift to the IRS. This means if you have four children, you can currently give away up to sixty thousand dollars ($60,000) per year without the IRS even knowing about it. If you are married, each spouse has his or her own GTAE meaning couples can give up to one hundred and twenty thousand dollars ($120,000) each year;
- If you exceed the GTAE in a given year, you are required to report the amount in excess of the GTAE to the IRS on your tax return; but
- You will not have to pay a gift tax unless and until you have given away more than the Unified Credit Amount (currently about eleven million dollars ($11.2M) after the enactment of the Tax Cuts and Jobs Act of 2017) during your lifetime.
Clearly most of us (myself included) do not have to currently worry about the gift tax. But, it is important to report any sizable taxable gifts (those in excess of the GTAE) on your tax return because of their effect on your Unified Credit Amount. Each time you make a gift in excess of the GTAE during your lifetime, your Unified Credit Amount is decreased by that amount. If, for example, you made a gift of one hundred thousand dollars ($100,000) in 2018, you would report a taxable gift of eighty-five thousand dollars ($85,000) on your tax return and your Unified Credit Amount would be reduced by eighty-five thousand dollars ($85,000). If the Unified Credit Amount remains historically high it will likely have little effect on your estate planning but if they are lowered in the future it may require more complex estate planning to ensure you are not subject to the estate tax.
Second, you should consider the consequences gifting may have on the capital gains tax. The capital gains tax is levied on the difference between the purchase price of a capital asset and the sale price of a capital asset. If, for example, you purchased rental property for ten thousand dollars ($10,000) in 1965 and sold it in 2018 for one hundred thousand dollars ($100,000) you would have a taxable capital gain of ninety thousand dollars ($90,000) and would owe the IRS capital gains tax of approximately twenty percent or eighteen thousand dollars ($18,000).
- Instead of selling it, you gave the rental property to your son while you are alive he would receive your tax basis in the property (the price for which you purchased the property in 1965). As a result, he would have a tax basis of ten thousand dollars ($10,000) and he would have to pay the same eighteen thousand dollars ($18,000) in capital gains tax if he sold it for one hundred thousand dollars ($100,000); but
- If, instead of giving it away while alive, you left the rental property to your son at your death through your will or trust he would receive a “step-up in basis.” This means he would receive a tax basis equal to the fair market value of the rental property upon the date of your death rather than the price for which you purchased the property in 1965. Assuming the property was valued at one hundred thousand dollars ($100,000) on the date of your death, he would pay no capital gains tax if he sold it for one hundred thousand dollars ($100,000).
As you can see, all things being equal, it is often better to hold onto property until you pass away rather than giving it away while you are alive. If you give capital assets (real estate, stocks, etc.) away while you are alive the recipient of the gift will likely have to pay capital gains tax if they choose to sell the asset. If you hold onto the capital asset and it passes to the recipient at your death typically they will be able to avoid paying most, if not all, of the capital gains tax on the sale of the asset.
Finally, gifting can cause problems for anyone applying for Medicaid to pay for long term care costs. Medicaid is a federal program which can be used to pay for the costs of a nursing home but only if the applicant has less than two thousand dollars ($2,000) in assets. Medicaid also has a “look-back rule” which penalizes applicants if they have given away assets within five years of the date of their application. The purpose of the rule is to penalize those who attempt to qualify for Medicaid by giving their assets to family members in an attempt to look impoverished, but the rule can easily ensnare an innocent applicant who was regularly making contributions to a grandchild’s college fund or making donations to charity. Thus it is always important to review your gifting strategies as you get older.
Gifting can be a great part of your estate plan but should be done with caution. If you have any further questions about how gifting fits into your estate plan please contact us today to set up a consultation.
 The Unified Credit Amount is the amount of assets you are permitted to give away during your lifetime and at your death without being subject to the Gift and/or Estate Tax. The current Unified Credit Amount is about eleven million dollars ($11.2M) but that amount is subject to the whim of Congress and has historically been closer to one millions dollars ($1M).