As the year winds down, one topic on just about everyone’s mind is gifts - not just the seasonal presents under the tree, but also those big transfers of assets between family members that often get made at the end of the current tax year or beginning of the next.
The year in which a gift is made is important because of how the tax code treats gifts. The good news is that gift-tax exemptions can benefit lots of people, not just those in the very highest brackets.
In fact, the benefit is greatest for those who don’t qualify for multimillionaire status. While gifts are technically taxable, that status applies only to those over the very generous annual exclusion of $14,000. Then there’s a lifetime exclusion, which is more generous yet.
All this really means is you can give up to $14,000 each year and neither you nor the recipient will owe any federal income tax on the gift. Here’s another useful wrinkle: you can elect to split gifts between married couples, effectively doubling the amount transferred tax-free. Say one spouse makes a gift to a child for $28,000, but states that it’s from both parents. That way each spouse gets credit for that maximum $14,000 gift. This isn’t limited to family, by the way. You can make a tax-free gift to anyone.
As far as tax reporting is concerned, the easiest option is if the gift is cash. The gift is reported as whatever the cash amount is and that also becomes the cost basis for both donor and recipient.
If the gift consists of non-cash assets, it gets a bit more involved. The asset - securities, a car, works of art, etc. - must be reported at market value. For stocks, bonds, mutual funds and other easily traded assets, that’s easy to determine. But for more concrete “stuff,” it may be necessary to obtain an appraisal.
That’s very much worth the cost, because the IRS can cast a very critical eye on what it might consider an over- or under-valued gift. You’ll want to be able to back up any claim for what a gift is worth.
Once the market value has been obtained, it becomes the cost basis of the asset, both for the person making the gift and the one receiving it.
But there is a tricky footnote to this. Say you give a block of stock worth $14,000 to your nephew but your tax basis is less than that; you paid just $10,000 for the stock a few years earlier. If the nephew getting the gift (“donee,” in tax-speak) sells it for $15,000, his tax basis is that “carryover” amount - essentially your cost basis when you originally bought the stock.
So, the nephew’s capital gain is $5,000 - the difference between what you paid and what he received from the sale. On the other hand, if the gift assets are sold at a loss, the donee’s cost basis is the lower of the two possibilities - the market value at the time of the gift, or the donor’s cost basis.
Does that make your head spin? Mine, too! And that’s why a situation like this should be analyzed by a competent professional.
Back to the immediate tax consequences, though - even if a gift exceeds the $14,000 annual threshold (or $28,000 in the case of married couples), gift taxes still don’t have to be paid immediately. That’s because of the so-called “lifetime exclusion.” But you will pay taxes when you exceed that $5.49 million amount.
Of course, any taxes due from your estate will reduce the amount available for your heirs. But by thoughtful use of gifts while you’re living, you will have transferred appreciable assets out of your estate and into the hands of someone whose estate is likely smaller and whose tax burden is likely less.
Right now, I’m working with some clients to accomplish exactly that result. Three siblings jointly own a piece of real estate they want to present as a gift to another family member. One of my duties is to obtain an appraisal for the property.
Once the current market value is established, we’ll then deed the property to the relative. Right now - before the appraisal is done - it looks like the property will be valued somewhere in the neighborhood of $100,000. So, each of the siblings’ share of that gift will be well above the $14,000 limit.
That means each of these three donors will have to file a gift tax return (that’s IRS Form 709). They will declare the gift and attach a copy of the appraisal but won’t actually pay any tax. For the amount over the annual limit - probably $20,000 or so for each of the siblings - they will take advantage of the lifetime exclusion.
So, in this example, each will eat into their lifetime exclusion by that roughly $20,000 (based on dividing the total value by three, then subtracting the annual $14,000 limit). If this was the first time the lifetime exclusion was used, this would leave each of the donors another $5.47 million to work against in future years!
It’s only in very specific cases that clients actually bump up against that amount, so these tax law provisions can help almost anyone painlessly transfer funds to a family member or other loved one.
If you’re considering something like this, remember this very important fact - even if any gift tax should be due, it’s never the recipient who has to pay it. The donor is always responsible for any tax on a gift.
Finally, as to the timing, a gift of this kind can be made any time of year, but legal title must pass by Dec. 31 to be counted as part of that year’s transactions.
The main reason these decisions are often made at year-end is to evaluate other tax considerations. For example, if an asset is producing income, it may make sense to collect any last-quarter dividends, interest or rent first, then make the gift at the beginning of the new year. But a donor’s personal tax situation may just as easily dictate that the gift should be made before the year ends.
There’s no simple answer about what timing is best; it all depends on the details of the donor’s finances. This is another reason that these decisions shouldn’t be made without expert advice.
Old North State Trust, LLC (ONST) periodically produces publications as a service to clients and friends. The information contained in these publications is intended to provide general information about issues related to trust, investment and estate related topics. Readers should be aware that the facts may vary depending upon individual circumstances. The information contained in these publications is intended solely for informational purposes, is proprietary to ONST and is not guaranteed to be accurate, complete or timely.
Susan Willett is the director of trust services and oversees all aspects of trust administration for Old North State Trust, LLC. Old North State Trust, a North Carolina chartered trust company, provides: asset management services; income, estate and trust tax consulting; retirement planning and administration; and trustee and estate services to both individuals and businesses. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
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