When you give gifts to others, they are potentially subject to taxation. The gift tax law exists to stop people from giving gifts to avoid the estate tax.
Most people do not pay the tax because the gifts that they give fall within the amount of the annual gift tax exclusion.
In 2016 the amount of this annual gift tax exclusion is $14,000. This is a per person exclusion. You as an individual taxpayer can give as much as $14,000 to any number of others before the gift tax would become applicable.
There is no limit to the overall amount that you can give tax-free within a year, as long as you don’t give more than $14,000 to any one person.
It should be noted that this figure of $14,000 is periodically adjusted to account for inflation.
You don’t have to use the annual gift tax exclusion to give tax-free gifts to your spouse. Because of the unlimited marital deduction, you can give any amount of money to your spouse tax-free at any time, as long as your spouse is an American citizen.
Unified Gift and Estate Tax
The gift tax is unified with the federal estate tax. In addition to this $14,000 per year, per person gift tax exclusion, there is also a lifetime unified gift and estate tax exclusion. The amount of this exclusion in 2016 is $5.45 million. This exclusion is also subject to ongoing adjustments to account for inflation. 2017 it has increased to $5.49 million.
If you were to give more than $14,000 to someone in a given year, you could still give the gift tax-free if you used a portion of your lifetime gift and estate tax exclusion.
To explain by way of a very simple example, let’s say that you give your daughter $14,000 on New Year’s Day. You can give this gift tax-free using the annual gift tax exclusion.
Her birthday is six months later in June. You decide to give her $1 million for her birthday. The gift can be given tax-free, but you would be using $1 million of your $5.49 million unified lifetime exclusion. After you give your daughter this birthday gift, only $4.45 million would be left to apply to your estate and future lifetime gifts.
Transfer Tax Efficiency
Estate planning for high net worth individuals is going to involve the implementation of transfer tax efficiency strategies. If you want to transfer assets that exceed $5.49 million in value, transfer taxes are going to be a very real concern. The maximum rate of the unified gift and estate tax is 40 percent, so we are talking about a significant bite.
The utilization of the annual gift tax exclusion can be useful when you are looking for ways to reduce your transfer tax exposure. This exclusion facilitates tax-free asset transfers without reducing the amount of your available unified lifetime exclusion.
A significant amount of money can be transferred tax-free using the annual lifetime exclusion if you give gifts over an extended period of time.
Since this is a per person exclusion, you have a $14,000 per person, per year exclusion to utilize. If you are married, your spouse has his or her own exclusion.
As a couple you could combine these two exclusions. You and your spouse would have the ability to give a total of $28,000 annually to any number of gift recipients free of transfer taxes.
Suppose you have two married children. You could give $28,000 to each husband and each wife every year. This would facilitate the transfer of $112,000 annually tax-free. If you do this for 10 or 20 years you can transfer a significant amount of money without incurring any transfer tax liability.
You don’t have to give direct cash gifts to use tax-free lifetime gifting as a tax efficiency strategy.
Many families who are concerned about transfer taxes and asset protection create family limited partnerships. It would be possible to distribute shares in a family limited partnership on an annual basis that stay within the amount of the annual per person gift tax exclusion. By doing this you could reduce your estate tax exposure as you set aside resources for the well-being of family members.
The annual gift tax exclusion can also be used to fund certain types of irrevocable trusts that are used to gain estate tax efficiency.
Schedule a Consultation
If you have questions about the gift tax law or any other estate planning concern, we are standing by to assist you. Our firm offers no obligation consultations to our neighbors here in the greater Indianapolis area, and you can send us a message through our contact page or give us a call at (317) 684-1100 to set up an appointment.
Paul A. Kraft, Estate Planning Attorney
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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