Reducing Estate Tax by Making Gifts
Making gifts during your life can provide you with tax savings and more.
One way to avoid or reduce estate tax is to give away property during your life. This provides you with more than just tax savings; you also get to see the recipients enjoy your gifts.
Currently, you can make an unlimited number of $12,000 gifts of cash or other property each year, completely tax-free. To ensure these tax savings, you need remember only that no individual recipient can receive more than $12,000 in a calendar year. If you left the same gifts at your death and they were subject to estate tax, the recipients would see their gifts shrink by at least 39%.
How the Annual Exclusion Works
The $12,000 annual tax exemption rule (called the "annual exclusion") is pretty straightforward. For instance, if you give $25,000 to someone, $12,000 of it is exempt from gift tax, but you must pay gift tax on the remaining $13,000.
The exclusion amount is indexed for inflation, rising in $1,000 increments as the cost of living goes up.
Couples: Double Your Exclusion
Couples can combine their annual exclusions, meaning that they can give away $24,000 worth of property tax-free, per year, per recipient. In fact, even if only one spouse makes a gift, it's considered to have been made by both spouses if they both consent. (Internal Revenue Code § 2513.)
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Joe and Faye, a couple in their late 70s, want to give their son and his wife money for a down payment on a house. Both Joe and Faye take advantage of their $12,000 exemptions to give a total of $24,000 to their son and another $24,000 to his wife. As soon as the first of the year rolls around, they can give away another $48,000.
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Gifts to Your Spouse
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All gifts you make to your spouse are tax-free, as long as he or she is a U.S. citizen. If your spouse isn't a citizen, the limit on tax-free gifts is currently $120,000 per year. (Internal Revenue Code § 2523(a).) However, there's seldom a reason to make large gifts to your spouse. If you each own about the same amount of property, you could worsen your tax situation by saddling your spouse with an estate that's so large it will be taxed at his or her death.
Timing Your Gifts
To make the most of the annual exemption, keep in mind that it is based on a calendar year. If you miss a year, you can't go back and claim that year's exemption amount. But if you spread a large gift over two or more years, you may escape gift tax complications. For instance, if you give your daughter $20,000 on December 17, $8,000 of it is taxable. You'll have to file a gift tax return (by April 15 of the next year), and you'll use up $8,000 of the total amount you can give away or leave free from estate tax. But if you give your daughter $10,000 in December and wait to hand over the other $10,000 until January 1, both gifts are tax-free.
Giving Away Non-Cash Property
Not only gifts of cash can be spread over several years. You can give away some stocks now, some next year. You can even give real estate in pieces -- physical pieces, if that's possible, or pieces (percentages) of ownership.
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Solomon and his wife Rhoda want to give their vacation cabin to their son Gerard. The cabin has a fair market value of $75,000, but their equity is only $40,000 because there is still $35,000 left on the mortgage. In November, Solomon and Rhoda sign a deed transferring the cabin to Rhoda and Gerard as joint tenants, meaning that Rhoda and Gerard each own a 1/2 interest in the property. (Solomon gave Gerard his $20,000 share of the equity in the cabin.) Gerard's gift from his parents is tax-free, because together they can give him up to $24,000 tax-free each calendar year.
The next calendar year, Rhoda gives her half-share, worth $20,000, to Gerard. Even though only Rhoda makes the gift, the IRS considers it, for tax purposes, to have come from both spouses.
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