How to Make the Most of the Federal Annual Gift Tax Exclusion

Dec 18th 2014
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For taxpayers looking to pass wealth to beneficiaries without any dire tax consequences, the simplest and easiest method is often the best approach: Just give cash or property away to your loved ones. All you have to do is make gifts to family members that are covered by the annual gift tax exclusion. In many cases, you don’t even have to file a gift tax return.

Such gifts can systematically reduce the size of your taxable estate. In addition, the family may realize income tax savings in the future. But there’s a downside: You have to relinquish complete control over the gifted assets.

Here’s the basic premise: Under the annual gift tax exclusion, you can give gifts of cash or property to someone up to a specified amount without paying any federal gift tax. The annual exclusion, which is indexed for inflation in increments of $1,000, is $14,000 for 2014 (the same as it was in 2013). It is projected to remain at the $14,000 level in 2015.

Despite little upward movement in the annual exclusion, your clients still have plenty of latitude in distributing assets to beneficiaries. The key aspect is that the exclusion is applied on a per-recipient basis. Thus, for instance, you can gift the maximum amount to a sibling, child, and grandchild, or several of these, in the same tax year with no gift tax problems. Furthermore, the annual $14,000 exclusion is doubled to $28,000 for joint gifts made by a married couple.

By using the exclusion judiciously from year to year, a married couple can easily transfer amounts valued into six figures, all on a tax-free basis.

Example: Suppose that a married couple, Jack and Jill, have three adult children and seven grandchildren. Jack and Jill each give a holiday gift of $14,000 to each child and grandchild in 2014. In one season of giving, Jack and Jill have reduced their joint estate by a total of $280,000 ($28,000 x 10 recipients).

You don’t have to file a gift tax return to benefit from the annual gift tax exclusion, but your spouse must provide consent to joint gifts on a return. Clients may consult you for assistance in this area.

If you’re giving away stock instead of cash, consider various other tax rules. For example, if the stock is later sold at a gain, it will be taxed at the tax rate of the holder, presumably at a lower rate than if you had sold it yourself. For this reason, you may want to give away low-basis stock and hold onto high-basis stock that can provide you with a valuable tax loss. In other words, figure the income tax ramifications into the equation.

Also, be aware that a gift made directly to a financial institution to pay for tuition or to a health care provider to pay for medical expenses doesn’t count toward the gift tax exclusion. So you can pay a grandchild’s college tuition bill next semester in addition to giving the same grandchild $14,000 in 2014 and another $14,000 in January—all of it free of gift tax.

Finally, there’s one more gift tax arrow in your quiver: The lifetime gift tax exemption. This exemption, which is $5.35 million for 2014, is available after you’ve exceeded the annual gift tax exclusion. However, using the exemption erodes the remaining estate tax shelter. Recommended approach: When possible, you might limit your lifetime gift-giving to amounts covered by the annual gift tax exclusion.

Related article:

How to Trim Taxes While Playing Santa

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