With the possibility of significant change to gift and estate planning laws on the horizon, many HCM clients are revisiting their long-term family gifting strategies.
If you would like to make gifts to children, grandchildren, or anyone else you care about, or if someone else makes gifts to your children, there are important factors to consider. Without proper planning, your family could incur a sizeable income, gift, or estate tax bill, which would mean less of your accumulated life’s work would go to the people you love.
Decide When to Make Your Gifts
If you have significant assets you intend to give to others, one of the first elements of planning is to decide when you’d like to gift those assets. Taxes are an important consideration, but before worrying about the financial aspects too much, consider:
- Is there any chance you will need the money in your lifetime?
- Are your beneficiaries capable of handling the gift responsibly if they were to receive it today?
- Does anyone you care about need help now?
- Do you have any charitable intentions in the near or long-term?
- Would you be willing to use trusts as a part of your planning solutions?
Most people’s estate values don’t come close to the level that would trigger an estate tax liability (currently, the estate exclusion is $11.7 million for individuals and $23.4 million for married couples. The current administration would like to reduce that benefit by 70% to $3.5 million per individual / $7 million per family). Even if your family will never flirt with these limits, there are still good reasons to consider making gifts before you die.
Your children and grandchildren likely have more money worries now than they will in a few decades when they’re presumably more financially secure and most likely to inherit your money. Additionally, giving during your lifetime allows you to see the impact of your gifts in your children’s lives and the benefits they produce.
Keep in mind, there is no rule that says the only way to make a gift is to write your kids a check. You can accomplish your goals and have a little fun too. A family Disney Cruise for ten or fifteen people will reduce the size of your estate, buy you one-on-one time with your grandchildren, and provide built-in playmates and babysitters that will give you and your children “grownup” time together at dinners on board. Everybody wins (except Uncle Sam).
If your estate will be subject to tax if the new reduced exclusions are put in place, it makes sense to consider the wisdom of transfers now to take advantage of the large exclusions while they last.
Minimizing Taxes on Gifts
The most common way people make gifts is through direct cash transfers. Cash transfers can also provide certain benefits regarding basis. So, if you are considering making transfers, please discuss the choice of assets with your advisor before proceeding.
If you decide to make gifts, one of the first considerations is properly managing the Gift and Estate Tax Limits. Under current rules, the IRS sets limits on how much you can give to a person in a single year without needing to file a gift tax return and not having it count against your lifetime exclusion. For 2021, the amount one person can give to another is $15,000; if your spouse also wants to make a gift, they could also give up to $15,000 without filing a return or using part of their exclusion. To be clear, this is $15,000 per gift recipient. As donors, you and your spouse may give $15,000 to as many people you choose, related or not, without limitation. So, if you have four grandchildren, you could each give them $15,000, moving $120,000 out of your estate, not have it count against your lifetime exclusion amount, and still not need to file any gift tax returns. If you don’t each have the money in your individual names to make these transfers individually, there are solutions for that too.
Many people know about the $15,000 annual limit, but mistakenly believe that gifts in excess of that amount would result in a gift tax being owed. That is not true. In most cases people can give substantially more without triggering any tax liability at all; however, a gift tax return would need to be filed so the IRS can keep track of your lifetime gifts.
In addition to making gifts directly to individuals, you may also make unlimited tax-free gifts for the education of children, grandchildren, siblings, students you are mentoring, or anyone else you care about. The choice is yours! To qualify, educational expenses must be paid directly to the educational institution. Educational gifts may only be used for tuition; they cannot go to books, room, board, transportation, beer, or pizza. Prepayment of tuition is normally acceptable so long as the payments are made after the student is admitted to school.
To gain additional tax-advantaged educational benefits, you may also contribute to a student’s 529 account, but that gift will be subject to the $15,000 annual gift rule. However, a special regulation in the tax code allows you to use up to five years’ worth of gift exclusions in a single year when contributing to a 529 account, allowing you to give up to $75,000 at one time under today’s rules. This strategy allows you move more tax-advantaged money out of your estate sooner.
Similar to education, you can take advantage of unlimited gifting to help loved ones with medical expenses. These amounts must be paid either directly to the healthcare provider or health insurer. Eligible expenses include the diagnosis, cure, mitigation, treatment or prevention of disease, injury, or other conditions requiring medical care. In some circumstances, transportation and lodging for the person receiving care may be covered as well. However, if the person receiving care is reimbursed by medical insurance, then any gift made to pay for the care is no longer exempt from the annual giving limits.
Choosing Which Assets to Gift
The specific assets that you would like to give will have a bearing on when you should make the transfer. If you’d like to give your child or grandchild an appreciated asset (real estate, stocks, collections, etc.(transferring business interests is outside the scope of this article)), it may be best to wait to do that through your estate plan so you can take advantage of the tax-free step-up in basis. (Note, this benefit may go away with potential legislation being discussed now, which is why time is of the essence.)
Typically, when you make lifetime gifts (rather than transfers at death), your beneficiary receives your tax basis which could result in a large taxable gain to your beneficiary. However, under current law, property transferred at death receives a step up in basis to the current fair market value of the property, eliminating any income tax due on appreciation that has accrued up to that point in time . On the occasion that the value of the property you want to give has gone down in value, it could be advantageous to gift the property during your lifetime so the carryover basis to your beneficiary may provide a valuable tax-deductible loss.
Considerations When Making Gifts to Minors
If you would like to make a gift directly to a child or grandchild, you can do so through a custodial account for the benefit of the minor in accordance with your state’s version of the Uniform Gifts/Transfers to Minors Acts. A custodian holds onto the property until the minor reaches a certain age as designated by statute, typically 18 or 21. In Ohio, you can choose an age between 18 and 25; if you don’t choose an age, it defaults to 21.
Because children (usually) earn less than their parents or grandparents, in the good ol’ days people would transfer substantial investments into their child’s name to utilize the child’s lower tax brackets. To address this “deemed abuse,” in 1986 Congress passed the “kiddie tax” law. The rules have changed several times since then, but it now applies to dependents up to age 18 and to college students from 19 to 23 years old. If a child has more than $2,200 in unearned income, the kiddie tax kicks in: the first $1,100 is not taxed, the next $1,100 is taxed at the child’s income tax rate, and anything exceeding $2,200 is taxed at the parents’ rate. Financial aid is an additional important planning consideration when deciding whether and how to make such a gift. Because the money in the account belongs to the child, this could have a substantial impact on the financial aid they can receive for college. The federal student aid formula typically expects a student to contribute up to 35% of their assets toward their college education annually, while parents are expected to contribute at most 5.6% of their assets.
One of the most rewarding aspects of building wealth is using it to take care of the people in your life that you care about. Gifts are an excellent way to put your cumulative life’s work to good use. The rules around both lifetime and estate transfers may be changing very soon. As a result, timely planning has never been more important. With proper planning, you can help ensure that you have done everything possible to provide your kids and/or grandkids the tools they need to thrive, while losing as little as possible to Uncle Sam in the process.
| Mike Hengehold, CPA/PFS MST RICP®
Mike is the Founder and President of HCM Wealth Advisors. Over the last 30 years, he’s provided financial planning guidance to a myriad of families to help them realize their financial dreams. Mike is an avid homebrewer and animal lover, and when he’s not at work you can often find him on the golf course working on his short game.