How to Use Strategic Gift Giving to Minimize your Tax Exposure
By Justin Fok, Esq.

Annual gift giving is one way to reduce your future estate tax liability. Gift giving can allow your heirs to benefit from your estate while you are still alive, as well as reduce the future burden of taxes imposed on your estate. Under the gift tax rules, each person can give gifts of up to $13,000 every year, to as many people as they like. That is to say that if you want to give all three of your children $13,000 every year for the rest of your life, you can do so without any tax implications. If you are married, you and your spouse can combine your gifts to give $26,000 per year to as many people you wish. This is called the annual gift exclusion. As long as your gifts to any single person do not exceed the annual gift exclusion, there is no need to worry about gift taxes.

Should you wish to give more than the annual exclusion, you can still do so without paying any tax during your lifetime. That is because each person also has a $1 million lifetime exemption. This exemption, however, is tied to your future estate exemption. Any amount you give over the annual gift tax exclusion is applied to this $1 million dollar exemption. At your death, the amount of your lifetime exemption that you have used up is deducted from your estate tax exemption. For example, if you were to give $18,000 a year to your son for the next ten years, you would use up $50,000 of your lifetime exemption. ($18,000 - $13,000 = $5,000 over the exclusion each year. $5,000 x 10 years = $50,000) If you were to die in 2009, when the estate tax exemption is $3.5 million, at your death the $50,000 used from your lifetime gift exemption would be subtracted from the $3.5 million estate tax exemption, and your estate would only receive a $3,450,000 exemption. While $50,000 is a relatively small amount for someone with a $3.5 million estate, it is clear that with some forward thinking, it is possible to maximize the wealth which you will pass on to your heirs without having to pay burdensome taxes.

What is considered a gift?

A gift is made when property is freely transferred without getting anything of worth in return. Common gifts include money, stock, real estate, motor vehicles, forgiveness of debt, and transferring property into joint tenancy. Low interest or interest-free loans can also be considered gifts, so it is important to discuss these matters with an attorney if they are substantial sums.

In order to be considered a gift, the recipient must retain complete control over the property. If the giver receives some benefit from the property, then it is not considered a complete gift. In addition, the recipient must receive a “present interest” in the gift. This means that the recipient must be able to access and use the gift for themselves at the time the gift is made. Giving someone a check for $100 which they cash the next day would be considered a tax exempt gift, putting $100 dollars in a trust fund which they can access in twenty years, while still a gift, is not tax exempt.

Giving gifts of appreciated property

For the purposes of gift taxes, the IRS assumes the gift’s fair market value. This can create some tax issues when giving gifts of real estate, stock, or art; or any other gift which is appreciated in value. When someone buys property, for example real estate, the price that they paid is their “tax basis.” This is the number which is used to calculate the capital gains on this property if the owner decides to sell it. For example, a house bought for $100,000 is sold ten years later for $250,000. Capital gains tax is assessed by subtracting the tax basis ($100,000) from the sale price ($250,000) to determine the taxable gain ($150,000). How does this apply to gift tax? If you give property to someone which has appreciated in value, you are taxed for the value of the property at the time of the gift ($250,000 in our example above). However, the tax basis of the property remains the same for the recipient of the gift. Therefore, when the recipient tries to sell the property many years down the road, the capital gains are assessed at the original tax basis. This is one reason that certain appreciated property is best left to your heirs after your death: because the tax basis on inherited property “steps up” to the current market value, therefore a recipient of inherited property faces much lower capital gains taxes.

Annual gift giving

The easiest way to reduce your potential estate tax exposure is to create a program of annual gift giving. This involves giving multiple beneficiaries (sons, daughters, etc.) an annual gift up to the maximum gift tax exemption amount. The benefits to this type of program are to be able to see your wealth utilized while you are still alive, and your beneficiaries do not have to wait for your death to be able to use your money. Some common ways that gift giving can be rewarding for the giver are helping with a down payment on a house or helping a college student pay bills. In the second scenario, however, it is possible to make gifts that do not count towards the yearly gift exemption.

Tax excluded gifts

Certain gifts do not count towards your annual gift tax exemption, that is, you can make these gifts in addition to the $13,000 annual exemption. Gifts which pay for someone else’s school tuition or medical bills are tax excluded, provided the gift is paid directly to the institution and not to the beneficiary. Gifts which you make to a citizen spouse are tax free, no matter how large they are. Gifts to a non citizen spouse are tax free up to $125,000 a year. Gifts to tax exempt charities are also tax free.

Drawbacks of gift giving

Strategic gift giving is not for everyone, and if your estate is projected to be below the estate tax exemption then you may have little financial motivation to give. However, for those who do decide that gift giving will be financially beneficial, there are some other aspects of gift giving to consider. First, you give up control of the property which you give away. Therefore, you must determine if you can live comfortably without the assets which you are considering giving away. Second, once you give the gift you no longer have control over how it is used. The beneficiary could turn around the next day and spend the entirety of the gift on something you deem frivolous. These are things which must be taken into consideration when contemplating a plan of strategic gift giving. As with any estate planning device, an experienced attorney can help you to navigate the pitfalls and loopholes of a plan such as this, in order to minimize your estate tax exposure and maximize the benefit for your heirs.

For questions on or comments regarding this article, please email Attorney Fok at: jfok@jclawoffice.com