UPDATE: Updated numbers related to this article can be found in our more recently released article, Tax Cuts and Jobs Act: Overview of Provisions Affecting Individuals.
The IRS has announced that the annual gift tax exclusion is increasing next year due to inflation. After five years of being stuck at $14,000, the exclusion will be $15,000 per recipient for 2018 — its highest point ever.
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
The federal gift tax applies to the giver of a gift, not the recipient, for amounts above a specified level. 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.
Unlike most other IRS inflation-based adjustments, the annual gift tax exclusion increases only in increments of $1,000. Thanks to relatively low rates of inflation, it’s taken five years for the annual exclusion amount to increase.
To illustrate how it works, 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, if you gift an amount that’s above the annual gift tax exclusion, you can also tap into the lifetime estate and gift tax exemption. 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 from one spouse to the other spouse,
- Gifts to a qualified charitable organization,
- Gifts made directly to a health care provider for medical reasons, and
- Gifts made directly to an educational institution for a student’s tuition.
For instance, 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. (See “Section 529 Plans: Make Five Years of Gifts in a Year” at right.)
Do you need to file a gift tax return? 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.
A gift tax return is required if you individually exceed the annual gift tax exclusion amount or a joint gift with your spouse collectively exceeds the amount. 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.
This year end, estate planning is complicated by the potential for sweeping tax law changes. 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.
Absent any radical developments, there still would be an incentive to give lifetime gifts from a tax perspective. 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.
Generally, the value of the assets for gift tax purposes is their fair market value. However, 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 he or she subsequently sells the property. Depending on your situation, you might arrange to sell property first and give the cash proceeds to another family member. The subsequent gift is covered by the annual gift tax exclusion.
Transferring wealth for your family typically calls for long-term planning. To maximize the tax benefits, you should engage in a systematic series of gifts over several years. 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.
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 ($5.6 million in 2018). Consult with your advisors before year end to discuss your short- and long-term options.
Section 529 Plans: Make Five Years of Gifts in a Year
Normally, a gift made directly to a family member to pay for college education costs would be covered by the annual gift tax exclusion, up to the limit of $14,000 in 2017 ($15,000 in 2018). But there’s a special tax break available for transfers to a Section 529 plan, a type of education savings program that’s run by individual states.
For a transfer to a Sec. 529 plan, the tax law allows you to make a one-time contribution that’s effectively treated as if it’s made over five years for gift tax purposes. In other words, you can gift the equivalent of five years’ worth of contributions in a single year.
For instance, if your grandson plans to attend college next year, you and your spouse may be able to transfer up to $150,000 to a 529 plan designating him as the beneficiary ($15,000 x 2 spouses = $30,000 x 5 years = $150,000). The entire transfer in 2018 will be exempt from gift tax. That could pay for most, if not all, of the college expenses he’s likely to incur. Contact your tax pro for more information.