Everyone enjoys receiving gifts, and most people enjoy giving gifts. Of course, giving gifts has both legal and tax implications. Before making large gifts, be sure to understand what the implications are to your taxes and estate plan.
Generally, there are two types of gifts: annual exclusion and lifetime. The IRS allows anyone to gift up to $15,000 annually to an unlimited number of people. This is the annual exclusion gift. The annual exclusion gift has no tax implications; neither the giver (giftor) or receiver (giftee) pays any tax. The annual exclusion gift is a free gift.
What happens if a gift is made exceeding $15,000? There are tax implications to large gifts. Gifts exceeding $15,000 reduce the giftor’s federal estate tax exemption by the amount of the gift. The recently implemented tax legislation increased the federal estate tax exemption to $11.2 million through 2025 (after that, the exemption will return to $5.5 million unless extended by Congress). Provided the giftor’s federal estate tax exemption is greater than the amount of gift, no tax is owed.
For example, Farmer Tom gifts a $1 million farm to his daughter. Farmer Tom’s estate tax exemption is reduced from $11.2 million to $10.2 million. Neither Farmer Tom nor his daughter owe taxes on the gift. Farmer Tom can gift an additional $10.2 million before any tax will be owed on a gift. Additionally, Farmer Tom can give $15,000 to his daughter each year with no tax implications.
Any federal estate tax exemption not gifted during a lifetime will be used by the giftor at death. In the above example, Farmer Tom will still have $10.2 million available at death. If Farmer Tom’s net worth is less than $10.2 million at death, no estate taxes will be owed. When making large gifts, it is important to be aware of your current net worth, as well as the potential growth of your net worth.
Any asset may be a gift
Just about any asset can be gifted. Obviously, cash is the easiest asset to give as a gift, but machinery, livestock and grain can be gifts. Real estate can be gifted as in the example above. However, gifting real estate can be problematic if the giftor wants to stay below the annual exclusion amount.
In this situation, consider placing the real estate in an LLC and gifting LLC ownership. By using the LLC, each gift is transferred by internal LLC documents, which remain private. Gifting land by deed requires a deed to be prepared and recorded for each gift, and the recorded deed is also public information. LLCs are an excellent means for gifting, especially when using the annual exclusion.
When giving a gift — in an attempt to reduce potential estate tax liability — the best asset to gift is an asset that is likely to appreciate in value. Using the above example, Farmer Tom gifts the $1 million farm because the farm is on the edge of town and has significant development potential. When Farmer Tom dies 10 years later, the farm has increased in value to $3 million. Farmer Tom was essentially able to reduce his estate by $3 million by giving a $1 million gift.
Gifts are reported to the IRS by filing a Gift Tax Return (Form 709). Gifts exceeding the annual exclusion should be reported on a Gift Tax Return, so that the IRS can reduce the federal estate tax exemption. Some accountants also file gift tax returns for annual exclusion gifts. Be sure to discuss reporting requirements with your tax preparer before making gifts.
With the higher estate tax exemption, gifts are not as important an estate planning tool as in the past. However, gifting still has its place in planning. Also, gifts are often made due to benevolence and not just for tax planning. Consider discussing the giving of gifts with your estate planning attorney or accountant to see if it should be incorporated in your plan.