Suppose you are fortunate enough to have an estate large enough to be subject to the estate tax upon your death. You might be considering ways to give some of your wealth to your family and loved ones now, thereby reducing the estate tax when you pass on. This tax strategy is important to consider over the next few years. The estate tax is set to revert back to about half of the current lifetime gift and estate tax exclusion beginning in 2026.  

Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible; in turn, the gift recipient thinks they have to pay income tax on the gift received. Nothing can be further from the truth. To fully understand the ramifications of gifting, one must realize that gift tax laws are related to estate tax laws. Uncle Sam does not want you to give away your wealth before you pass away to avoid the estate tax. For individuals who die in 2022, federal law allows $12.06 million (lifetime estate tax exclusion) to pass to heirs estate-tax free. Any excess amount is subject to an estate tax as high as 40%.

Amounts you gift above the annual gift tax exclusion amount prior to your death reduce the lifetime estate tax exclusion and will therefore subject more of your estate to taxation.

Example: Jeff gives his daughter $100,000 in 2022. This is $84,000 more than the $16,000 annual gift tax exclusion. Jeff will need to file a gift tax return reporting the gift. The $84,000 excess (and any additional excess amounts from other years) will reduce his estate tax exclusion, whatever amount it may be, in the year he dies.

The law does provide exceptions where gifts can be made without reducing the lifetime exclusion, including the following:

• Annual gift exclusion available each year to any number of individuals. The amount is periodically adjusted for inflation, the amount for 2022 is $16,000 (up from $15,000 in tax years 2018-2021). The recipient does not have to be a relative or an adult. Unlimited amounts can be gifted to a U.S. citizen’s spouse. Gifts can be cash or the transfer of real or personal property.
• Directly pay medical expenses. This applies to amounts paid by one individual on behalf of another individual directly to a medical care provider as payment for that medical care. Payments for medical insurance qualify for this exclusion.
• Directly pay education expenses. This applies to amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual. The tuition can be for any level of schooling—elementary, secondary, or post-secondary. Costs of room and board, books, supplies or other similar expenses aren’t eligible as direct payments, nor are contributions to qualified tuition programs (also known as Sec. 529 plans), which have their own gifting rules not covered in this article.

If the gift giver is married and both spouses agree, gifts to recipients made during a calendar year can be split between the husband and wife, even if only one of them gifted the cash or property. By using this technique, a married couple can give $32,000 in 2022 to each recipient under the annual limitation discussed previously.

Gifting Techniques:

High-Wealth Individuals – If you are a high-wealth individual who would like to pass on as much to your heirs as possible while living, without reducing the lifetime exemption, you could directly pay your future heirs’ medical expenses and education expenses in addition to annual gifts of cash or property of up to $16,000 (2022). You may want to do this even if you are not a high-net-worth individual, to avoid filing a gift tax return.

Education Expenses – When you pay the qualified post-secondary education tuition for another individual, it does not mean (as is usually the case for medical expenses) that someone cannot benefit taxwise. Tax law says that whoever claims the student as a dependent is entitled to the American Opportunity Credit or Lifetime Learning Credit for higher education expenses if they otherwise qualify.

Gifts of Appreciated Property – Consider replacing your cash gifts with gifts of appreciated property, such as stock for which you have a “paper gain.” When you gift an appreciated asset, the potential gain on the asset transfers to the recipient. This works for individuals, except for children subject to the kiddie tax, which requires the child’s income to be taxed at the parent’s tax rate if it is higher than the child’s rate. It also works great for contributions to charitable organizations. Although not subject to the gift tax rules, not only does an appreciated asset gifted to a charity get you out of reporting any gain from the appreciation, but you also get a charitable tax deduction equal to the fair market value (FMV) of the asset. The deduction for these gifts is generally limited to 30% of your adjusted gross income (AGI), but the excess carries over for up to five years of future returns.

Remember that to utilize this year’s annual exclusion amount, the gift must be transferred to your designated recipient by December 31. Exclusion amounts not used this year do not carry over to next year. So it’s never too early to start your 2022 gifting. 

In addition to the strategies above, you can use more complex gifting strategies involving various trust techniques to minimize future estate tax and take advantage of the current more significant exemption. If you need assistance with planning your gifting strategies, please call Cray Kaiser at 630-953-4900.