Gifting & the IRS

The IRS has certain guidelines in regards to large gifts.

Although the IRS does not concern itself with minor gifts to friends or families, it does take the opportunity to heavily tax those gifts that exceed a certain limit. The gift tax is a progressive one, meaning it increases as the amount given increases. Knowing this limit is important for two reasons. First, individuals can know when they will incur such tax liability. Secondly, individuals can use this limit as an estate-planning tool.

The Annual Exclusion

The amount one can pass gift tax-free varies from year to year based on expected inflation rates. For 2010, the amount is $13,000. This means an individual can pass $13,000 per person per year. The amount of people is unlimited. Also, this applies to each individual; therefore, a husband and a wife can both use their own annual exclusion without affecting one another’s.

Tax Rate

For 2010, the maximum gift tax rate is 35 percent; however, 2010 is somewhat of an odd year because for 2010 only the estate tax was repealed and the gift tax is limited to the maximum individual income tax rate. This “tax relief” will be short lived though, because unless Congress changes the law before the year is up, estate and gift taxes will go up to 55 percent in 2011.

Lifetime Exclusion

Also to be considered is an annual lifetime exclusion of $1 million. This amount allows for gifts that exceed the annual exclusion to pass tax-free. However, every dollar used of the exclusion is counted against the estate tax exclusion. For example, if $500,000 of the annual lifetime exclusion is used, that individual’s estate tax exclusion is reduced by $500,000. Therefore, the best strategy is to stay under the annual exclusion amounts because both “freebies” the IRS gives will be used to their full extent.

Estate Planning

By gifting the annual exclusion amount or less, a person can participate in effective estate planning. For example, assume a married couple has three children and six grandchildren. With a total of nine beneficiaries receiving $13,000 each, each spouse can reduce their gross estate by $117,000 for a total reduction of $234,000 between the two spouses. If this is repeated from year to year, a couple can greatly reduce their gross estate, which if over the gross estate exclusion amount could incur hefty estate taxes. Many would agree they would rather gift money to their heirs than let the IRS tax it at their death.

Exemptions

Gifts that go to any type of charitable organization are not counted towards the annual exclusion. In addition, gifts that are between spouses are not counted towards the exclusion because they qualify for the unlimited marital deduction. Therefore, gifts of any size to charities and to a spouse can be given tax-free.

References

• Tax Guide For Investors: Tax Rules for Gifts
• State Farm Insurance: Federal Estate Tax Update 2002-2010
• Carter, Ledyard & Milburn LLP: Annual Gift Tax Exclusion Amount to Increase to $13,000 as of January 1, 2009