It is surprising how many people ask me how they can give more than $14,000 to someone without paying taxes. Practically speaking, the current $14,000 annual gift exclusion isn’t really a limit on the amount you can give someone else. Now, hold on . . . please let me explain this statement before any of my fellow CPAs have a conniption!
In the United States, there are few restrictions on the transfer of property from one person to another. You can, legally and quite literally, give everything you own to someone else while you are alive (called a “lifetime gift” or “inter vivos” transfer) or you can leave it to them when you die (that would be a “bequest” or “testamentary gift”). Whether the transfer is made during or after your lifetime, an important question will be, “will there be any taxes owed?” Here are some basics about our federal estate and gift tax system (under the current laws):
Estate Taxes – Each individual can leave up to $5,250,000 to their beneficiaries without incurring federal estate taxes. This lifetime exemption could increase in the future because it is indexed for inflation (it was $5,000,000 in 2011 and $5,120,000 in 2012). While there are many rules, complexities and exceptions, potential estate taxes can be determined in three steps or less:
1. Add up all of the deceased person’s assets to arrive at their “gross estate” – if less than $5,250,000, there will be no estate taxes (if over that amount, then we go to the next step).
2. Figure the person’s “taxable estate” by deducting all of the following from their gross estate: funeral expenses, debts they owed, any amounts passing to a spouse (the “marital deduction”), any amounts passing to charities (the “charitable deduction”) and any estate taxes paid to a state government – if the net amount is less than $5,250,000, no federal estate taxes should be due (if over that amount, then we go to the final step).
3. Calculate the actual estate tax due by applying the estate tax rates to the net taxable estate. Estate tax rates range from 18 percent to 40 percent. The amount of estate taxes is reported to the IRS on Form 706.
Here’s an example of the math: A married man passed on with a $10,000,000 gross estate. He left $4,000,000 to his wife, $740,000 to his church and the remaining $5,260,000 to his son. To arrive at the man’s taxable estate, the $4,000,000 left to his wife would be treated as a marital deduction and the $740,000 left to his church would be treated as a charitable deduction. Before estate taxes are applied to the remaining $5,260,000 left to his son, the man’s lifetime exemption of $5,250,000 would be subtracted. Therefore, only the remaining $10,000 would be subject to estate taxes. The estate tax due would be $1,800 (18 percent on a taxable estate of $10,000).
Gift Taxes – Gift taxes were established to prevent individuals from giving their assets away to avoid estate taxes at death. Individuals can give up to $14,000 each year (the “annual exclusion amount”) to as many persons as he or she would like without triggering gift taxes or reporting of the gift to the IRS on Form 709. Gifts to your spouse, gifts to charities, and paying tuition or medical expenses for someone else (as long as you pay the institution directly) don’t have to be reported and are not counted toward the $14,000 per person per year limit. The annual gift exclusion amount is indexed for inflation as well. (Remember the old $11,000 per year gift limit? That was for 2002 through 2005.)
The “Million Dollar Question,” and the point of this column, is, “What would happen if you exceeded the $14,000 annual gift exclusion amount?” The short answer is, “not much” for most people. You would be required to file Form 709 with the IRS to report the gift. However, no gift taxes are due on your gift until you give away more than your $5,250,000 lifetime exemption (yes, you read right, you can use your $5,250,000 lifetime estate tax exemption during your lifetime to make large tax-free gifts). There could be income taxes due if an asset is sold by the gift recipient, but we’re not talking about income taxes right now.
Here’s another example to illustrate gift taxes and how they are related to estate taxes: A single woman wins the lottery and has $10,000,000 after taking the lump sum and paying income taxes. She decides to share her good fortune with her five siblings. She gives each of them $1,000,000. She files Form 709 with the IRS and uses $5,000,000 of her $5,250,000 lifetime exemption (she’d still have another $250,000 of her lifetime exemption remaining, plus any future increases for inflation). She’d owe no gift tax. She could also give each sibling an additional $14,000 each year under the annual gift exclusion. If, later, our most eligible bachelorette gives another $5,000,000 to her siblings or leaves it to them at her death, there could be hefty gift and/or estate taxes (because she only had $250,000 left of her lifetime exemption).
The bottom line is, unless you have over $5,250,000 in total net worth, you can likely give others as much as you want without triggering gift taxes. Individual situations vary, so consult with a qualified tax professional before making any large gifts.
David D. Holland is a certified financial planner and practitioner in Ormond Beach. He can be contacted at (386) 671-7526. Email your questions to