ESTATE AND GIFT TAXES
ESTATE AND GIFT TAXES
Proposed vs Current … a Heads-up!
It’s been in the press for months … the Democrats unveiling of the Build Back Better Act. Within its 881 pages are significant changes to the tax code with drastic impacts on current estate planning strategies and gifting rules. High tax bracket and wealthy taxpayers will be the most affected class of taxpayers … assuming the proposed revisions are passed in current form.
Again, please note that what follows is a brief summary of proposed legislation. As such it is very likely to be altered as negotiations work through the House Rules Committee and the House of Representatives before a final bill is presented to the Senate. So, there may not be an impact on current 2021 rules.
Proposed Estate & Gift Tax Revisions
- Federal estate tax exemption reduced from the 2021 amount of $11.7 million to $5 million effective January 1, 2022. (There are reports that this provision seems to be off the table. We’ll see.)
- Gift tax exemption reduced from the 2021 amount of $11.7 million to $5 million effective January 1, 2022. (To accommodate questions received, we’ll cover Gifting in more detail below.)
- Transfers of interests in a closely held entity … valuation discounts would be eliminated.
- Maximum Estate Tax Rate remains capped at 40 percent.
- Grantor Trusts established and funded before the enactment of the new law would be grandfathered.
- Eliminate or constrain the use of:
- irrevocable life insurance trusts
- Grantor Retained Annuity Trusts (GRATs)
- Qualified Personal Residence Trusts (QPRTs), and
- Grantor Charitable Lead Annuity Trusts (CLATs).
Gifting … Exclusions and Taxation
Here’s a recap of the 4 key points as they exist today in making gifts:
- What does the IRS recognize as a gift?
- What are the gift tax rules?
- Who pays gift taxes?
- How do givers gain?
Note: All the following refers to federal gift tax rules. There is no Virginia Gift Tax.
What’s a Gift?
The IRS defines a gift as the transfer of money, property or other assets by one individual to another while receiving nothing, or less than full value, in return. Any type of property may be considered a gift to recipients.
Some examples:
- Stocks
- Land
- Use of or income from property
- New car
- Sale of something at less than its full value
- Interest-free or below-market interest loan
The value of completed gifts, that exceed excludable amounts, may result in a gift tax. More on that in a bit.
Note: A gift is completed when the donor no longer has “dominion and control” over it. Making a completed gift forfeits asset ownership and control by the donor.
There are two time-lines affected by gift tax exclusions: annual and lifetime.
Annual Gifting Limits
This year single taxpayers may make annual tax-free gifts of $15,000 per recipient.
The IRS considers a gift made by a married couple from joint property to be given half from each spouse. That means married couples enjoy an exclusion of $30,000 annually per recipient.
Please note the emphasis on per recipient. That means that a donor can give anyone up to $15,000 in assets a year, free of federal gift taxes. Married couples could give away $30,000 annually to each of an unlimited number of recipients.
If you give more than $15,000 ($30,00 for married couples) in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax. It just means you need to file IRS Form 709 to disclose the gift.
Additionally, gifts to pay tuition or medical expenses are also free of gift tax. To qualify for this break, the donor must make the payment directly to the institution.
Lifetime Gifting Limits
The federal tax law provides for a lifetime gifting exclusion which sets the dollar limit of what you may gift during your lifetime. Again, the recipient or recipients are your choice.
Single taxpayers may now gift up to $5.49 million per recipient.
Married couples enjoy a lifetime tax-free gift limit of $11.7 million per recipient … $23.4 million combined.
Note: Gifts made that exceed the Annual Gifting Limits are subtracted from the donor’s Lifetime Gift exclusions.
Who Pays Gift Tax … Donor or Recipient?
The gift tax is only an issue for individuals that plan to gift very large amounts over their lifetime or will have big estates when they pass away. The reason … the gift tax exclusion is calculated on cumulative gift amounts
upon the death of the donor. Given the significant lifetime exclusion limits, the vast majority of Americans and their estates will never be faced with paying this tax.
Filing the gift tax return, IRS Form 709, discloses excesses of annual gifting limits. So, if you don’t gift anything in your life and don’t exceed the lifetime gifting limits, your whole lifetime exemption will apply against your estate when you die.
The person receiving the gift usually doesn’t need to report the gift. If you are a donor who is financially able and generous enough to use up your exclusions, you may indeed have to pay the gift tax … rates range from 18% to 40%.
Takeaways
The federal gift-tax exemption applies to the total of an individual’s taxable gifts made during life. Both the Annual and Lifetime Gifting Limits are substantial. The result is that relatively few American taxpayers are likely to exceed these amounts and be subject to the gift tax. That said, making gifts that don’t exceed the Gifting Limits can yield substantial estate tax savings … particularly if you keep at it for several years.
Note: If the revised Gift Tax exclusion were to pass as written, there will be no “clawback” for use of the current exclusion amounts if the donor passes away at a time when the applicable exclusion amounts have been reduced.
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