When you are interested in wealth preservation you should know the facts about transfer taxes. We have a federal estate tax, and most people are aware of it. We also have a federal gift tax that may not be on your radar.
Gifts Are Taxable
The estate tax was originally enacted in 1916. Wealthy people immediately started giving large gifts to their heirs to avoid the estate tax. The enactment of the gift tax a few years later closed this window of opportunity.
Why can you give gifts to people on their birthdays without giving accompanying gifts to the IRS as well? This is because there is an exclusion or credit. In fact, there is more than one exclusion.
Let’s look at the annual gift tax exclusion first. Each year you can give a certain amount to an unlimited number of gift recipients free of the gift tax. This amount is subject to change as inflation takes its toll. At the current time the annual gift tax exclusion amount is $14,000 per recipient per year.
Within a calendar year you can give this much to any number of people without incurring any gift tax responsibility.
Would you have to start paying the gift tax if you gave a gift to someone in excess of $14,000 during a particular year? The answer is no, because there is another exclusion that you could utilize.
The estate tax and the gift tax are unified. In 2013, the unified lifetime exclusion is $5.25 million. This unified exclusion extends to the gifts that you give while you are living that are taxable and the value of your estate.
So, if you gave a $28,000 gift to someone in a given calendar year, $14,000 of it would pass free of taxation because of the annual gift tax exclusion. You could give the rest of the gift tax-free using a portion of your unified lifetime exclusion.
Additional Give Tax Exemptions
While we are on the topic of tax-free giving we should mention the fact that there are a couple of other ways that you can give gifts free of taxation without impacting the amount of your lifetime exclusion.
There is an unlimited educational exemption. You are allowed to pay the school tuition of students gift tax-free. This is tuition only, and the payments must be made directly to the schools.
There is also an unlimited medical exemption that can be utilized. Under the tax code, you may pay medical bills for others free of the gift tax. You could do this for any number of people, and there is no limit to the amount of money that you can use to pay these bills.
This unlimited medical exemption also extends to the purchase of health care insurance for the benefit of someone else.