Large end-of-year gifts for children and grandchildren

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As an estate planning attorney, I often notice that people have some misconceptions about how much money they can give away without incurring gift taxes.

Can I only give $16,000 without incurring taxes?

This is a common misperception of first-time donors. The “annual exclusion per donee” is the maximum amount of a gift (per gift recipient) that need not be reported to the IRS; it is simply excluded from the gift tax. It doesn’t even appear on your tax return.  The amount is $16,000 for the 2022 tax year but it gets adjusted periodically. It will be $17,000 for 2023.

You can give much more per individual, still without incurring taxes, but now the IRS wants to know how much you gave. Why? See further below.

For example, if you have 10 children and grandchildren, you can give (10*$16,0000=) $160,000 without having to report any of this to the IRS. Just to be clear, you can give to anybody without needing to report, and the number of people you give to is unlimited, provided that each of them does not receive more than the exclusion amount for the year ($16,000 for the 2022 tax year).

I have two grandchildren starting their own businesses, how much taxes do I have to pay if I give a gift of $80,000 to each of them this year?

First, the gift to each grandchild (donee) exceeds the annual exclusion amount. So it must be reported. How much of the gift amount needs to be reported? The amount which exceeds the annual exclusion: $80,000 – $16,000 = $64,000, and since there are two recipients, you report $128,000. Almost always you still do not pay any gift tax, but this amount is tallied by the IRS to reduce your remaining lifetime Unified Tax Credit for gift and estate tax. The lifetime (cumulative) gift and estate tax exemption for 2022 is $12.06 million for individuals and $24.12 million for married couples filing jointly.

If you are below this amount, no taxes are due. This is historically very high, and the respective tax law that established this exemption (compare to the $16,000 exclusion) will sunset in 2025. See our previous post. The exemption for 2023 is $12.92 million.

I emphasize the distinction between exclusion and exemption. An estate planning attorney writing for Forbes didn’t get it quite right: “Annual Exemption: In addition to the lifetime exemption, there is also an annual gift tax exemption.” It should be ‘Annual Gift Tax Exclusion‘. In tax law attention to detail is not hairsplitting.

What is meant by Unified Tax Credit?

Many years ago the taxation for gifts and estates was different. By unifying the system the IRS made the tax code a bit simpler but also eliminated some abuses that occurred because of the different tax treatments. The accumulated dollar amount of gifts you make above the annual exclusion of $16,000 per donee will lower your remaining exemption amount (in 2022 $12.06 million). What you give during your lifetime, will lower the amount of your estate that is not subject to estate tax.

For example:

During your lifetime you make, as an unmarried individual, 6 million dollars in gifts above your annual exclusion amounts. When you die, the dollar amount of your estate that exceeds $6.06 million ($12.06 million – $6 million) is subject to estate tax.

Is it better to give gifts during your lifetime than to leave a larger amount to your heirs?

This is a loaded topic and deserves its own post, especially when it comes to intangible benefits, but briefly:

You sometimes hear that despite the Unified Tax Credit it is more tax efficient to pay federal gift taxes on a transfer of property than paying estate taxes for the exact same transfer after death. This is because gift taxes are exclusive, while estate taxes are inclusive; explained nicely here. This only has relevance for the very wealthy.

There is another more important purely financial consideration: how the basis for the transfer is calculated, aka as bifurcated basis rule. For gifts, the donor’s basis is your basis, and the property’s holding period is the donor’s holding period. When the gift recipient (donee) sells the gifted property she may incur large capital gains taxes if she is in a higher tax bracket.

However, in 2022, individual filers won’t pay any capital gains tax if their total taxable income is $41,675 or below. In consequence, it would make sense to gift appreciated property (value higher than basis) to younger relatives who don’t earn that much but could put the gift to good use.

In contrast to gifts, the basis for property that is transferred from a decedent to an heir is replaced with the fair market value at the date of the decedent’s death. This is often a step-up but could be a step-down when there are investment losses.

On a different note, in addition to pure altruism and the desire to enhance one’s reputation and influence, there are other psychological benefits to giving. In an influential paper “Generosity and Philanthropy: A literature review” they have been described as the ”joy of giving”, enhanced self-image, and mood, amongst others. In fact, these may be even more relevant reasons to be generous during one’s lifetime.

What special gifts are there that are not taxable?

“Tuition or medical expenses you pay for someone (the educational and medical exclusions).

Gifts to your spouse. Gifts to a political organization for its use. In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.” IRS: What can be excluded from gifts?

Gift in Trust

A Crummey trust (we wrote about it here) is a special trust to accumulate gifts made to a trust that takes advantage of the annual gift tax exclusion. Before Crummey vs. Commissioner, a gift into a trust was not considered a gift because it was not completed and therefore rather a ‘future interest’. This could be a good way for accumulating a sizeable pot of money for junior without diminishing the lifetime gift tax exemption. Restrictions apply, as they say.

In summary, if your retirement is otherwise secure, making lifetime transfers could be a very valuable estate planning strategy that is associated with tangible and intangible benefits to the donor. Things may get complicated, though, and you should strategize with your estate attorney, tax professional, and financial planner.

Related:

Who pays gift taxes and how much?

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