After five years of being stuck at $14,000, the annual gift tax exclusion will be $15,000 per recipient for 2018 — its highest point ever. According to the announcement by the IRS, it’s rising due to inflation.
Here’s what the recent increase in the exclusion may mean for you, including how annual gift-giving can lower your taxable estate.
Annual Gift Tax Exemption
For amounts above a specified level, the federal gift tax applies to the giver of a gift, not the recipient. Most gifts are sheltered from gift tax by the annual gift tax exclusion and the lifetime gift tax exemption (or both).
For starters, you can give gifts valued up to the annual gift tax exclusion amount each year without ever touching the lifetime exemption. For 2017, the exclusion is $14,000 per recipient. In 2018, it increases to $15,000 per recipient.
The annual gift tax exclusion increases only in increments of $1,000, unlike most other IRS inflation-based adjustments. Thanks to relatively low rates of inflation, it’s taken five years for the annual exclusion amount to increase.
To illustrate, let’s suppose you have three adult children and seven grandchildren. In 2017, you could give each family member $14,000 — for a grand total of $140,000 — without owing any gift tax. In 2018, you could give $15,000 to each recipient for a total of $150,000.
The annual gift exclusion is available to each taxpayer. If you’re married and your spouse consents to a joint gift — also called a “split gift” — the annual exclusion amount is effectively doubled to $28,000 per recipient for 2017. So, in the previous example, a married couple with ten family members could gift up to $280,000 in 2017 ($300,000 in 2018) completely exempt from gift tax.
Lifetime Estate and Gift Tax Exemption
In addition, you can also tap into the lifetime estate and gift tax exemption if you gift an amount that’s above the annual gift tax exclusion. The lifetime exemption effectively shelters from tax $5 million, indexed for inflation. The inflation-indexed amount for 2017 is $5.49 million per donor. It increases to $5.6 million for 2018.
However, if you tap into the lifetime gift tax exemption, it erodes the estate tax exemption amount that would be available when you die.
For instance, suppose an unmarried individual gives gifts to family members valued at $1,150,000 in 2018. After the annual gift tax exclusion is applied to $150,000 of gifts, the lifetime exemption can shelter the remaining $1 million from gift tax. That leaves an available estate tax exemption of $4.6 million if the individual dies in 2018 (assuming the decedent hadn’t ever tapped into his or her lifetime exemption in a previous year).
Exceptions to the Rules
Be aware that the following gifts are generally gift-tax exempt, preserving the full annual gift tax exclusion and unified exemption:
- Gifts to a qualified charitable organization,
- Gifts from one spouse to the other spouse
- Gifts made directly to an educational institution for a student’s tuition, and
- Gifts made directly to a health care provider for medical reasons.
Let’s say for example, if your granddaughter attends college, you might pay her tuition directly to the school for the 2017-2018 school year. The payments don’t count against the annual gift tax exclusion so you could still give her $14,000 in 2017 and $15,000 in 2018. Furthermore, you may take advantage of a special tax break for gifts made to a Section 529 plan for a student beneficiary.
For any gifts below the annual gift tax exclusion, you’re not required to file a gift tax return. However, you still may want to file one to establish the value of certain gifts of property with the IRS.
If you individually exceed the annual gift tax exclusion amount or a joint gift with your spouse collectively exceeds the amount, a gift tax return is required. For the latter, each spouse must file an individual gift tax return for the year in which they both make gifts.
The deadline for gift tax returns is April 15 of the year following the year of the gift, the same as the due date for personal income tax returns. (The deadline is moved to the next business day if it falls on a weekend or holiday.) So, for gifts made in 2017, you must file a gift tax return by April 17, 2018. However, if you extend your federal income tax filing to October 15, 2018, the extension also applies to your gift tax return.
Estate planning is complicated by the potential for sweeping tax law changes this year end. The current House bill would essentially double the life estate and gift tax exemption to $10 million (adjusted for inflation). After 2023, the estate and generation-skipping tax would be entirely eliminated and the gift tax rate would fall to 35%. The Senate bill also would double the exemption, but it doesn’t propose an estate or generation-skipping tax repeal or lower the gift tax rate. These proposals could change significantly over the next few weeks, however.
There still would be an incentive to give lifetime gifts from a tax perspective, absent any radical developments. For instance, you might gift securities or other assets to younger family members in lower tax brackets for two key reasons:
1. To reduce the size of your taxable estate. As long as a federal estate tax remains in effect, this could still be beneficial, especially to elderly taxpayers.
2. To transfer income-producing assets to younger family members in lower tax brackets. This could create income tax savings for your family over time.
Although the value of the assets for gift tax purposes is generally their fair market value, if you give away property, such as stock that has appreciated in value, the recipient must use your basis (usually, the original cost) to compute the taxable gain if they subsequently sells the property. You might even arrange to sell property first and give the cash proceeds to another family member, depending on your situation. The subsequent gift is covered by the annual gift tax exclusion.
When transferring wealth for your family, it typically calls for long-term planning. You should engage in a systematic series of gifts over several years to maximize the tax benefits. For example, you may arrange to give five family members gifts totaling $70,000 ($14,000 x 5) in 2017 and $75,000 ($15,000 x 5) in 2018. All of the gifts would be exempt from gift tax.
Consult with your advisors before year end to discuss your short- and long-term options. Your tax advisor may suggest other creative and sophisticated estate planning tools, including family limited partnerships (FLPs) and intentionally defective grantor trusts (IDGTs), designed to maximize the benefits of the $5.49 million exemption in 2017 ($5.60 million in 2018).