Lifetime Gifts Using the Annual Gift Tax Exclusion
For some people with larger estates, the $5,340,000 federal estate tax exemption is insufficient and further planning is necessary to reduce the exposure to estate tax liability. This issue is more pronounced as the "permanent" changes that went into effect January 1, 3013 may change and reduce the exclusion amount. Using a properly designed program of lifetime gifting can reduce the taxpayer's taxable estate at death and make sure that estate assets are transferred to children, grandchildren and other family members (for reducing taxable estates see Irrevocable Trusts and Planning with FLPs and LLCs).
Making the most of the unified credit, a taxpayer may gift substantial amounts during his or her lifetime and avoid taxation on the gifts. However, using the unified credit against your gift tax liability will reduce or possibly eliminate the credit available for use against the federal estate tax at death. Alternatively, utilizing the annual exclusion for gifts does not affect the unified credit.
The Internal Revenue Code provides for an annual exclusion of certain gifts by granting an exemption sheltering the gift from gift taxation each year. In 2014, the first $14,000 (annual exclusion amount) of gifts made to anyone during the calendar year is excluded from the total amount of gifts made. A donor is not limited by the number of annual exclusion gifts they can make every year. A donor can significantly reduce his or her estate with annual tax-free transfers to each of an unlimited number of individuals.
Gifts of the annual exclusion are not included in the calculation of your gift tax liability and therefore will not count against the federal estate tax credit. If the taxpayer transfers more than $14,000 to any one beneficiary during the year, the exclusion will cover the first $14,000 and only the amount over the exclusion will be taxable. If the unified credit is utilized, there may be no gift tax liability on the excess. While $14,000 seems like a modest amount, gifting of this type to multiple beneficiaries over many years will result in the transfer of sizeable sums.
Annual exclusion gifting can also reduce income taxes by shifting the tax on income from gift property from the higher-bracket estate owner to the lower-bracket beneficiary. Annual exclusion gifts do not cause a generation-skipping transfer (GST) tax when they are direct skips or gifts in trust for a single beneficiary.
The annual exclusion is only available for gifts of present interests in the gifted property. A present interest means that the person receiving the gift (donee) has an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property. The donee's enjoyment of the gift can't be postponed into the future. If the donee's rights to the gift is restricted causing postponement, the gift is one of a future interest and the exclusion will not be allowable. Whether the gift is a present or future interest is an issue of timing. The interest is not a present interest when title in the gifted property vests in the donee, but rather when substantial enjoyment begins for the donee.
Gifts to spouses are not taxable under the marital deduction rules.
The annual exclusion to a donee from a married donor can be twice that allowed from a single donor ($28,000 in 2014), by reason of the "gift-splitting" concept. Annual gifts made by a married donor can be treated as split between the spouses, even if the gift is given by only one spouse. Both spouses must consent to the gift-splitting.
Despite the fact that gifts to beneficiaries must be gifts of present interests giving the beneficiary the immediate right to the substantial use and enjoyment of the gift, there are certain statutory means for qualifying gifts in trust as gifts of a present interest. If the qualifying requirements are met, the annual exclusion will apply to gifts to beneficiaries in trust, gifts used to provide funds to pay premiums on a life insurance policy owned by a trust and to transfers of fractional ownership interests in an asset.
Unlimited Gift Tax Exclusion for Education and Medical Expenses
Donors may reduce transfer taxes by taking advantage of the unlimited gift tax exclusion for education and medical payments. The relationship between the donor and the donee is irrelevant. Payments must be paid directly to the educational or medical institution or service provider. Payment for education expenses must be to a 'qualifying' institution and the exclusion is subject to certain rules regarding the definition of an education or medical expense.