A parent can structure a gift of $1M to a child today such that neither the child nor the parent will pay any tax. A common misconception is that a person is limited in the amount of gifts he or she can give to friends or family. The truth is that there are no limits. Rather, there are consequences for the gifts…some are seemingly inconsequential, and some might require the person giving the money (the donor) to file gift tax returns or even pay a gift tax. Let’s review.
Annual Gift Exclusion ($10,000)
Many people think they are limited in their ability to gift to the annual gift exclusion amount. Originally set at $10,000 but adjusted for inflation to $18,000 for 2024, the annual gift exclusion is the amount a donor may give to a person without reporting the gift through a gift tax return. Neither the donor nor the recipient pays any gift tax associated with the gift. The threshold includes all gifts for a calendar year. A married couple can give double – each spouse can give $18,000 to each child. For example, if parents have 5 kids, each parent can gift $18k to each child per year for a total wealth transfer of $180 per year.
When is a Gift Tax Return Required?
Once a gift exceeds the annual exclusion of $18k in any calendar year, the donor must file a gift tax return (Form 709). But this does not mean that the donor (or recipient) will pay any gift tax. For 2024, a married couple can give away over $27M before paying any gift tax. Instead, the gift tax return acts as an accounting tool—the taxpayer is tracking how much he or she has gifted to date and how much more he or she can gift before hitting the threshold amount (again, $27M for a couple for 2024) and then being required to pay gift tax. Important note: the state of Washington does not tax or track any gifts. The gift tax return is a requirement from the federal government.
What is the Applicable Gift Tax?
If a taxpayer is one of the very few (lucky?) individuals to be able to cross the threshold into taxable gift territory, the gift tax quickly reaches 40%. That is, the amount gifted over the threshold amount for a married couple ($27M) will be subject to that 40% tax.
Income Tax Considerations
Neither the donor nor the recipient pays any income tax related to a gift. But there is some important nuance worth noting. The recipient of any gift retains the donor’s tax basis in the gift. If the gift is all cash, this issue is irrelevant. But, if the gift is of a capital asset that has increased in value, the income tax consideration is important. Assume Parent buys a piece of land for $100,000 20 years ago. Today, it is worth $1M. As shown above, Parent is able to gift that land to a child. Assuming no other gifts, Parent would file a gift tax return and pay zero gift tax. But the child would take Parent’s tax basis ($100k) with the effect that if child sold the property after receipt, he or she would then pay capital gains on the difference between the tax basis ($100k) and the sale price ($1M) at capital gains tax rates. This can be avoided (in these limited facts) if Parent instead gives the land to the child at death by Parent’s last will and testament because federal law grants a so-called “step-up” in tax basis at death to current fair market values.
What this means is that the nature of the gift (not only how much but also the object of the gift and its related tax basis) is worth planning to achieve the best mix of gift, estate, and income tax treatment.
Planning for Gifts
There exists ample opportunity to incorporate gifting into an estate plan, especially an estate that might be subject to an estate tax. Still, the nuance shouldn’t be overlooked. Work with a qualified attorney or CPA to establish a gifting plan. Also, note that Medicaid gifting is covered by a different set of rules outside the purview of this article.
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The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
