Annual Gifting I often advise older people whose income is greater than their expenses to consider an annual gifting program. Gifting is a very attractive alternative to more complex methods of estate planning. Back when the federal government taxed anything over the first $600,000 in assets you owned at your death, planners were constantly thinking up methods of getting assets out of their clients hands, but retaining the benefits of those assets for their clients. Arcane tax planning trusts like the Grantor Retained Annuity Trust and the Qualified Personal Resident Trusts were used to take the assets out of a taxable estate with minimal gift tax liability while retaining the right to receive income and live in your house. Now that the amount the federal government allows you to give away has increased to 5.34 million dollars, these complex planning methods are used less often. Creating a trust means creating a new legal entity. A legal entity that has to be administered by someone and has to file taxes. That costs money that reduces their attractiveness. Putting assets into these complex trusts also restricts your right to control the assets, limits you ability to use the $14,000 annual exclusion (explained below) and limits your flexibility. A gifting program does not have these drawbacks. If youve had a bad year, with increased expenses and decreased income, you can adjust your annual gifts. And the administrative burden can be little more than writing the check. Moreover, gifting while you are alive allows you to see the results of the gift. You can swell with pride as your son invests your gift in a 529 plan for his toddlers future college education or adjust your plan when your son buys something frivolous or self destructive or his creditors or his spouse seizes the asset. Annual Exclusion Each calendar year, the Federal Government gives every individual an exclusion for each gift worth up to $14,000 to any recipient. Since the annual exclusion is based on the calendar year, you can give away $14,000 to someone on December 31 and another $14,000 on January 1 and have each gift qualify for that years annual exclusion. For a couple, the exclusion is a total of $28,000 of gifts given to each recipient. Therefore, if a couple gave $28,000 to their son, his wife, and each of their three grandchildren, they could give away $140,000 ($28,000 x 5) without incurring any gift taxes. Its a good idea to make multiple gifts, but always remember that any gift to your daughter-in-law would not be shared with your son if they divorce and can be attached by her creditors. You may need to file a gift tax return if you use your spouses exemption. Use of this $14,000 gift tax exclusion is, therefore, a very powerful estate planning tool, but this tool must be used carefully. The exclusion is only available for a present interest in property. That means, for example, if you signed over your fully paid insurance policy worth $14,000 to your child, the exclusion would not apply and your Exemption Equivalent would be reduced by $14,000. The $14,000 exclusion for gift taxes is not available to gifts of insurance policies because the Internal Revenue Service looks at a life insurance policy as a future interest and not a present interest. Only a present interest can qualify for the $14,000 exclusion. Therefore, giving a gift uses some of your $5.34 million Exemption from Gift and Estate Taxes, unless it is a gift of a present interest that qualifies for a $14,000 annual gift tax exclusion. There are ways around the problem, though, including creating a trust and giving beneficiaries a present right to withdraw the funds you put in. Medicaid Gifts also have ramifications if the giver later applies for benefits under the Federal Medicaid Program. Medicaid is a Federal program administered by each of the States available to individuals who are indigent. Unfortunately, because of the high cost of hospital and nursing home care, and the high percentage of individuals who spend a significant amount of time at the end of their life in a hospital or nursing home, many individuals become indigent and need to rely upon the Federal Medicaid Program. If you have long term care insurance, you have insured against this risk and are safe as long as your policy pays benefits for five years that are sufficient to pay your medical bills. The Federal Medicaid Program, because it is designed to pay for the medical care of the indigent, penalizes individuals who have given substantial gifts. Essentially, the Medicaid Program obtains financial records, looking back five years from the date an individual applies for Medicaid for any evidence of a substantial gift. For example, a Medicaid income worker may look at the financial assets and tax returns of a Medicaid applicant and notice that, at one point, the Medicaid applicant owned a vacation home. After the Medicaid worker inquires as to what happened to the home, and learns that the home was transferred to children, the worker will inquire as to what they paid for it. If the transfer was a gift, it incurs a transfer penalty. Medicaid penalizes a Medicaid applicant by making that person ineligible for Medicaid, based upon the amount of the gift given to others. Basically, the amount of all gifts given is divided by $7,787.00 Getting back to our example, if the vacation home was worth $200,000, the Medicaid applicant would be ineligible for a little more than 25 months ($200,000 / $7,787 = 25.68) from the date that the medicaid applicant runs out of money. This is true even though the Medicaid worker only looks back at five years worth of financial information. To avoid a period of medicaid ineligibility, therefore, you should always retain enough assets so that you will be able to pay for care for five years. Income Taxes Income taxes can also be affected by gifting. Capital gains are income taxes paid on the difference between the amount paid for an asset (the “Basis”) and the amount received at its sale. The federal government taxes this difference at a lower rate than the income you earn, such as your salary. When you give something away, the recipient also receives your “Basis” in the property transferred. This is complicated, so an example is in order. If you purchased your home for $100,000, gave half of it to your child when it was worth $200,000 and sold it together with your child for $400,000, your child would need to pay capital gains taxes on $150,000 (½ sale price, less ½ original purchase price). While there is a $250,000 exemption from capital gains from the sale of a residence, it only applies if the residence is owned and occupied by you for two of the preceding five years. If your children live in their own homes, the exemption will not apply since they never occupied your home as their residence. In contrast, if your children were to inherit your house at your death, the Federal government steps up the home’s “Basis” to its date of death value. Therefore, if your children inherit your $400,000 home in your Will and immediately sell it after your death, they pay no capital gains taxes. The same is true if your house is part of your Estate and is sold by your Executor - your Estate will pay no capital gains tax. The common solution to this problem is to give your home to your children, but retain a “Life Estate” in it. A Life Estate gives you the right to live in your house for your lifetime, so long as you are medically able to do so. The IRS considers a life estate a future interest since you retain the right to live in the house . The gift is only completed after your death, when your right to live in the home ends. Therefore, your children receive a step up in basis at your death and pay no capital gains.
Posted on: Mon, 10 Mar 2014 13:07:23 +0000
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