Reducing Estate Tax — Gifts

There are times when people would opt to give their property and money away during their lifetime. They do this instead of writing a will to ensure that their loved ones’ needs are taken care of while they are still alive, and also to reduce taxes that may be imposed on one’s estate.

As of 2013, the annual exclusion amount for federal gift taxes is set at $14,000, from $13,000 on the previous years. This means that you can give a gift up to $14,000 each to as many people as you wish within one year and be free from being taxed.

A gift exceeding $14,000 will be taxed, so keep in mind that if your estate’s value is more than the exclusion limit, any gift you would leave in your will may potentially be reduced by as much as 55% to cover for the estate tax. This may make the idea of giving gifts while you’re still alive much more appealing.

Reducing Estate Tax — Annual Gift Exclusion

The Internal Revenue Code has a tax exemption rule called the annual gift exclusion. This means that if you give a gift of up to the amount set as a cap, then that amount is tax-free, and any amount in excess of the cap is taxable. This year, it is set at $14,000 per gift per year. If you give your child $20,000 in cash gift in 2013, then $14,000 of that is tax-free while the remaining $6,000 is subject to tax.

The exemption may change through the years, because of inflation. In fact the limit was at $13,000 in 2012 and is now set at $14,000 in 2013.

Reducing Estate Tax — Doubling Your Gift Exclusion

Since each person is entitled to give a gift that is free of tax for up to $14,000 this year, there is a potential for you to double your exemption if you and your spouse both give gifts to others. Starting 2013, you and your spouse can jointly give gifts of up to $28,000 per person per year.

Suppose Rob and Jane would like to help out their child get a house for his family. If Rob and Jane within the same year give $28,000 to their child, and another $28,000 to the spouse, then that’s a total of $58,000 tax-free!

Reducing Estate Tax — Gifts to Spouses

Thankfully for spouses of US citizens, you can give each other any amount in gift without limit and still not pay taxes, according to the Internal Revenue Code. But if your spouse is not a US citizen, then there is a limit of up to 10 times the annual exclusion rate for ordinary gifts, i.e. $140,000 in 2013. Therefore, if you give a non-US citizen spouse a gift of $150,000, $140,000 is tax exempt while the remaining $10,000 is subject to tax.

Reducing Estate Tax — Timing

Timing is important in a lot of things, and the same applies to the giving of gifts. The exemption is based on the calendar year of when the gift was given, and cannot be retroactively made even if you meant to give the gift on another year. However, one advantage is that since it is based on the calendar year, if you wanted to give your child $27,000, then you can give $14,000 in December and the remaining $13,000 the next month, January, which is a new calendar year. However, if you give your child the full $27,000 in December, then only $14,000 is exempt from tax and $13,000 is subject to tax.

Reducing Estate Tax — Gifts of Non-Cash Property

The annual gift tax exemption applies to cash, as well as to bonds, stocks and other real or physical property. For example, if you want to give your friend stocks with a value of $50,000, you may give $28,000 worth of stocks in one year, and the remaining $22,000 in another to be qualified for the gift tax exemption.

But what if, for example, Rob and Jane would give a $50,000-car as graduation gift to their grandchild, then you can’t just divide the car in half and give one half now and the other half the next year. However, Rob and Jane can still avoid paying taxes if the car would be put in joint ownership between Jane and their grandchild, giving them each $25,000 interest inn the car. Then the following year, Jane can transfer her interest to their grandchild, therefor avoiding any gift tax.

Reducing Estate Tax — Gifts to Minor Children

Since young children, or those below 18 years of age, cannot be expected to take full responsibility in handling and managing a large amount of money, then you would want an adult to manage it for them until the child reaches a certain age.

Generally, there are two methods that you may use to give gifts to minor children:

  • Set up an irrevocable trust for the child, or
  • Set up a custodianship as long as it is authorized under state law.

To make this gift to a minor child qualify for the annual gift exclusion, it must meet the following conditions:

  1. The child must obtain outright property ownership by the time they reach 21 years old. The trust you set up for the gift should state that the property within the trust mush transfer to the recipient when they turn 21. Just the same, a custodianship must end by the time the child turns 21. But of course, the custodian is not prevented from spending the money for the child’s benefit before the child turns 21.
  2. If the recipient of the trust dies before turning 21, any property that remains from the gift must go to the recipient’s estate or to a person the recipient has named in a will or other legal document.

Use Caution When Giving Gifts

But do be careful about reducing your estate through the giving of gifts as you may risk giving away too much and be left with not enough for yourself. Just as you care about your loved ones, you need to ensure that your needs will be taken care of too and plan your gifting accordingly. If you have a large estate and stable source of income, then you may go right ahead with giving gifts.

A financial planner may give substantial help in laying out a plan for your gift-giving and other financial management concerns.

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