The concept of gifting is simply that you give something to someone or something for no value in return. That is, the donor gives something worth value to the donee (or the recipient). Its concept is simple but it is one of the most powerful tools utilized as an estate and business planning strategy.
Many people believe that gifts are limited in value to $17,000 (for 2023). That figure instead represents the “Annual Exclusion” gift –the maximum amount that may be given by an individual without the need to report the gift to the IRS. In fact, a person can give any amount he or she chooses. If it is under $17,000 per year, there is no reporting requirement. If it is over $17,000 but less than the federal Unified Credit (currently $12.92 million for 2023), then the person would need to file a gift tax return but would pay zero gift or estate tax. If a person gifts more than the Unified Credit amount, then he would owe tax equal to 40% of the value of the gift over the Unified Credit. This provides a substantial opportunity for gifting for the average person where the gifts will not exceed the Unified Credit of $12.92 million.
Gifting offers several advantages. First, Washington state imposes an estate tax but does not track or tax gifts like the federal government. Thus, gifting in any amount is an effective strategy to avoid the Washington state estate tax. Second, with regard to the federal gift and estate tax regime (where gifts are tracked and potentially taxed), a person can use the Annual Exclusion amount to move substantial assets out of his estate. Though seemingly limited to $17,000, a person can gift that figure to as many recipients as he wants (think $15k to each of a person’s children, grandchildren, nieces, nephews, etc, every year). For a couple, each can gift the $17k and therefore pass $34K from the combined estate. Third, the gifting also removes the appreciation of the asset out of the donor’s estate. So, if a person has an appreciating asset (maybe land for example) it would likely reduce estate tax exposure to gift the asset while the value is lower rather than waiting until the value increases.
Gifting can be used as an effective tax mitigation strategy for the individuals and couples that have a taxable estate. Alternatively, gifting can also be an effective strategy to preserve and protect assets when a person doesn’t have much money and has extensive medical or assisted living needs (e.g. Medicaid assistance). So, if you have a lot of money, we can use gifting to reduce tax. If you don’t have a lot of money, we can use gifting to preserve the estate for your heirs. Both goals have different strategies and different applicable gifting rules.
Gifts can further be leveraged with the use of valuation discounts. When we prepare large gifts (gifts in excess of the Annual Exclusion), it is often worthwhile to hire a company to prepare a valuation for the gift. Typically, the gift is structured as a gift of a minority interest in the asset. For example, mom and dad might gift a 49% interest in the family farm LLC to their children. That minority interest will likely discount the reported value of gift.
The gift will be further discounted by the lack of marketability discount and potentially others. The end result is that the parents may be able to report a gift valued at less than anticipated which is a method to pass assets to the next generation outside of the estate tax.
Let’s use an example for a federally taxable estate. In very rough numbers, if you make a one-million-dollar gift and those assets appreciate just 10%, your potential tax savings would be approximately $40,000 for the federal government and up to $200,000 for the state government for a total of $240,000. However, we can leverage the gift further through the use of valuation discounts discussed above. Assuming a 30% discount for lack of marketability and minority interest discounts, the tax savings could be even higher. Please keep in mind that the discounts are different for every case and every business and the Treasury Department has proposed regulations which may affect the ability to obtain some of the inter-family transfer discounts.
For gifts, the donee pays no tax on the receipt of the gift. And, for most gifts (except those gifts that exceed the $12.92 million Unified Credit), the donor pays no tax either. But, it is important to note that when you make a gift, the recipient inherits the donor’s tax basis in the asset. Conversely, when a person dies and an heir inherits an asset, the heir has a so-called “step-up” in tax basis which makes the tax basis of an asset equal to the fair market value of the asset as of the date of death (which equals a win for income tax planning). So, care must be taken to choose the appropriate asset for gifting that considers the likely appreciation, the tax basis of the asset, the goal of gifting, and other factors.
Talk to your local advisor to see if gifting is a good strategy for you.
* Licensed, not practicing.
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.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.