Gifting assets may save on taxes by reducing the size of your estate. Although the IRS levies a gift tax, smart planning lets you take advantage of a large lifetime exemption and a substantial annual limit. Gift and estate tax rates frequently change, however, so keep informed on new laws and rules governing wealth transfers to your children.
Estate and Gift Tax
The IRS levies income tax on estates that exceed the exemption limit of $5.25 million. As of 2013, the estate and gift tax rates had reached 40 percent. In addition, gifts are taxed if they exceed the annual exemption of $14,000 (as of 2013) per recipient. The limits apply to either spouse; in effect a married couple can gift $28,000 tax exempt in 2013. The individual giver pays any gift tax, not the person who receives the gift. If you make a gift to a spouse, the gift is tax exempt. For your children, the transfer of money for educational or medical expenses directly to the institution is also exempt from gift tax.
Taxpayers with large estates can take advantage of a "unified credit" for gifts they make. This option can save on estate taxes, which may be set at an even higher rate in the future. If gifts to your children exceed the annual limit, you can apply the excess toward the lifetime gift-tax exemption of $5.25 million. If you do not apply this exemption, you can pay the tax on the amount over the annual limit, and then credit that amount to any estate tax that will eventually be due.
Definitions of a Gift
The IRS considers any transfer of property or money to your children as a gift. Also considered a gift is the use of property, or income from property, without receiving something of equal value in return. A loan of money that does not need to be returned, or can be repaid at no interest, may also be a gift, in the eyes of the IRS.
As an individual you must report gifts subject to gift tax to the IRS on Form 709. If a married couple "splits" a gift to take advantage of the annual exemption, that also must be reported, even if half of the split gift doesn't reach the exemption amount. The recipient does not need to pay income tax on the gift or even declare the gift unless it has a foreign origin. The exemption amount is regularly indexed for inflation; therefore as the years go by it's a good bet the exemption will increase, allowing even greater tax savings when your heirs declare your estate to the IRS.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.