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Many high earners want to know the most tax-efficient strategies for gifting assets to the people they care about. With concerns over lower estate tax exemptions in the future, BWM Financial is helping clients pass their wealth to loved ones in a tax-efficient way during their lifetimes.  We explain the fundamental gifting rules, benefits, and methods to be considered when creating meaningful and tax-advantaged lifetime gifting strategies.  

What is gift tax and who pays it?  What is the gift tax exclusion amount for 2021? 

Gift tax is a federal tax paid by the person who makes the gift and receives nothing (or less than the gift’s full value) in return. This tax rate may range from 18% to 40% and applies to gifts exceeding your annual gift exclusion, which is a certain flat dollar amount that varies based on your filing status. In general, single taxpayers may gift up to $15,000 per year to any one person free of gift taxes. For married taxpayers filing a joint tax return, the gift tax exclusion doubles to $30,000 per year.  

This means a married couple with two kids may gift $30,000 per year to each child without gift or estate tax implications. But imagine they wanted to gift their son $70,000 this year to help him buy a home. Could they make a gift over their annual $30,00 exemption amount without paying taxes? Yes, the IRS says they can make a tax-free gift over their annual exemption if they apply their excess gift of $40,000 [$70,000 gift – $30,000 exclusion] towards their lifetime “bucket” of tax-free gifts. This is called the lifetime exemption amount.   

What is my lifetime exemption amount? 

Your lifetime exemption amount, also known as your lifetime gift and estate tax exclusion, is the amount of assets you can give away tax-free during your lifetime. In other words, it’s the amount of your estate that will not be subject to taxes at the end of your life. 

For a single taxpayer, the current lifetime exemption amount is $11.7 million in 2021. Married taxpayers have a combined exemption amount of $23.4 million. Today’s high exemptions were enacted by the Tax Cuts and Jobs Act in 2017 and provide an opportunity to gift away a substantial amount of wealth tax-free. But this window of opportunity is limited. In 2026, the lifetime exemption is scheduled to revert to $5.49 million per individual, adjusted for inflation. However, new proposals may lower the lifetime exemption to only $3.5 million per individual possibly effective by January 1, 2022.  

The good news is if you move assets out of your taxable estate today, your current $11.7 million lifetime exemption amount will apply, even if the exemption is reduced in upcoming years.  This means if you were to gift away or transfer assets today that are in excess of the lower future exemption, you will have secured the use of today’s larger $11.7 million exemption. 

Here is a basic example to illustrate. Suppose you’ve never made a gift over your annual $15,000 exemption amount, but this year you decided to transfer $10 million to various loved ones into trusts for their benefit. Your gift would be completely tax-free because it is under your current $11.7 million lifetime exemption.  

Now imagine in 2022 the current $11.7 million lifetime exemption for a single taxpayer is reduced to $3.5 million. Since your $10 million gift was considered tax-free at the time it was made, your estate will not owe taxes on your gift even though it was well over the new $3.5 million lifetime exemption.  However, keep in mind that you will have already exhausted the new $3.5 million lifetime exemption. This means any future gifts over your annual $15,000 exemption amount would be subject to gift and estate taxes. 

Do gifts need to be reported to the IRS? 

In general, single taxpayers who gift over $15,000 per year and married couples who gift over $30,000 per year to a single person are required to file a gift tax return (Form 709). There is an exception for gifts made to your spouse. If your spouse is a U.S. citizen, the IRS says you can gift him or her as much as you want tax-free and you do not need to file a gift tax return. These rules are different if one or both spouses are not U.S. citizens.   

Keep in mind, being required to file a gift tax return doesn’t mean you’ll owe gift taxes. Form 709 simply helps you and the IRS keep track of your lifetime estate tax exemption. In general, you will only owe gift taxes if you have already used up your large lifetime exemption. 

Even if you’re not required to file a gift tax return, in certain situations you may benefit from filing one anyways. This is especially true if you gifted assets that are hard to value, such as artwork or an ownership interest in your family business. Filing a gift tax return is a way to disclose your transfer of assets. It also starts the clock on the statute of limitations. This generally makes it more difficult for the IRS to challenge the valuation of your gift more than three years after you file your gift tax return. 

Certain exceptions and special rules exist for calculating gift taxes. Because of this, its best let your CPA know of any meaningful gifts you made during the year. You may want to do this even for gifts that were under your annual $15,000 exclusion amount.   

Do I have to pay taxes on gifts received? 

You typically do not owe taxes for merely receiving a gift. However, you may owe taxes if you later sell the asset you were gifted for a gain. Your taxable gain would be the difference between your new sales price and the original purchase price paid by the person who gave you the gift.  

For instance, suppose your grandparents gifted you 10 shares of stock worth $500 each. They purchased this stock for $100 per share. If you decided to sell one share at its current value of $500, your taxable gain would be $400 [$500 new sales price – $100 original purchase price]. In addition, your holding period for purposes of long or short-term capital gains would be calculated starting with the date your grandparents purchased the stock. 

For example, imagine the stock your grandparents gifted you was purchased by them on May 1, 2020. If you were to sell the stock on May 1, 2021, or sooner, you would owe short-term capital gains. But if you were to sell the stock on May 2, 2021, or later, you would owe more favorable long-term capital gains. Remember, investments must be held for at least one year and one day to receive the long-term capital gains tax rate.  

You may also owe taxes if you received gifts that generate income. In this case, it’s just like owning any other investment. You don’t owe taxes when you receive the investment. But if it pays income while you own it, you pay the taxes. Before filing your tax returns, make sure your CPA knows about all your sources of income, including income received from gifted assets. 

Is it possible to make larger gifts without reducing my lifetime exemption? 

There are carve-outs for educational and medical care gifts that will not count against your lifetime exemption.  The IRS says that payments made on behalf of another individual that are paid directly to an educational or medical provider are tax-free. 

For example, imagine you have a nephew with $50,000 in medical bills from a sudden health problem. You and your spouse would like to cover the entire bill but are worried about paying gift taxes for the amount over your $30,000 annual exemption. Rather than gifting your nephew cash to cover his bill, you can simply pay his medical provider directly without any incurring any gift taxes. 

The same rule applies for qualified educational costs. You may cover another individual’s qualified tuition or other educational costs without triggering gift taxes if you pay the educational institution directly.   

On top of that, the IRS generally allows a special tax-free way to frontload five years of gifts into 529 college savings plans in a single year. This is a way to gift multiple years’ worth of the $15,000 annual exemption at once. For single taxpayers, this means a one-year contribution of up to $75,000 [$15,000 annual exemption x 5 years]. For married taxpayers filing jointly, the maximum one-year contribution jumps to $150,000 [$30,000 annual exemption x 5 years]. Although these gifts are made tax-free, the IRS requires that you make a special election by filing a gift tax return. 

How can BWM Financial help?  

As part of our service to clients, BWM Financial will evaluate the tax-efficiency of your current gifting and estate planning strategy. We can look at your full financial picture and show you the most tax-advantaged ways of transferring wealth to loved ones without impacting your lifestyle or future needs in any way. 

Our Director of Wealth Planning, Chris Pegg, and other advisors can work directly with your CPA and estate attorney to help you create more advanced estate planning strategies if needed. These strategies will be covered in our upcoming articles and involve Grantor Trusts, Family Limited Partnerships, Charitable Remainder Trusts and more. 

If you need help with estate planning, please contact BWM. While we are not tax advisors, we will provide high-level advice that can be evaluated with your CPA and estate attorney and then put into action. 

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Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA BWM Financial.  The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.