As you likely know, the gift tax is a deferred estate tax that is triggered whenever a gift of a certain size is made during a given tax year. If a person gives a gift that has a value in excess of the annual exclusion, then a gift tax return must be filed. However, the annual exclusion presents a problem for individuals with significant assets who wish to make large gifts without triggering gift tax.How can this problem be addressed?
The "loan to avoid the gift tax" strategy is one method taxpayers can use to solve this problem. Mind you, it requires substantial investments of time and energy, so it may not feasible for everyone.
In this post, we will go over the mechanics of this multi-step strategy and the information you’ll need to put it into practice. This strategy is not overly complex, so you won’t overwhelm clients when explaining it. Additionally, you will do a lot to build your credibility and reputation. Even though it’s a very niche strategy, it has the potential to save a client large sums of money.
To begin, you’ll need to be aware of the annual exclusion for gifts. It tends to change fairly often, so you should check the law at the start of each tax year. For the years 2018 and 2019, the annual exclusion is $15,000. This means gifts below this amount can be made without a return. The exclusion applies to individuals, so a married couple would be allowed to jointly contribute up to $30,000 without triggering gift tax.
Suppose an individual has an estate valued in the 8-figure range and wishes to avoid the estate tax. They would like to chip away at their estate by making a 6-figure gift to a recipient. Normally, if the individual simply made a cash gift of this amount, the gift tax would be triggered. But, if the individual makes a loan, then the gift tax return will not need to be filed. After the loan is transferred, the individual can make yearly gifts to the recipient, who can service the loan with the gifts. As long as the gifts are below the annual exclusion, the recipient can pay off the “loan” using the gift money from the taxpayer.
Let’s consider an example. A married couple makes a loan to their child in the amount of $500,000. Then, the couple makes yearly gifts to the child just below the annual exclusion. Given the current annual exclusion, the child would be able to pay off the entire balance of the loan in less than 17 years. When structured this way, the transaction would not trigger a gift tax.
For those clients who can dedicate sufficient amounts of time and energy, this strategy may be workable. At the very least, it's worth recommending.
Jorgen Rex Olson is a graduate of Washington State (B.A., cum laude, 2008) and the Indiana University (McKinney) School of Law (J.D., 2012). He writes for Mackay, Caswell & Callahan, P.C., one of the leading tax law firms in New York State.