Now that the year 2021 is quickly becoming a distant memory, it is time to write or update your financial plan for 2022. One of the important elements of the plan is the gifts that you are going to give to family, friends and non-profits. We will discuss the basic rules of taxes on gifts and will be happy to address any complex scenarios that you may run into. These rules are likely to change for the worse, by 2025 at the latest. Continue reading for more details.
What Counts as a Gift, with the Gift Tax Exemption?
According to the IRS, the gift tax applies to the transfer of property by one individual to another while receiving nothing (or less than full value) in return, regardless of whether the donor intends the transfer to be a gift. The IRS identifies property of various types as a gift such as:
- Use of income or property
- Even an interest-free or reduced-interest loan
You can count on the IRS to broadly construe gifts.
What Doesn’t Count as a Gift, with the Gift Tax Exemption?
Gifts do not generally include most presents to spouses, tuition or medical expenses, gifts to political organizations, or gifts that are not more than the annual exclusion for the calendar year. There are of course exceptions to these rules, such as non-citizen spouses.
What Can you Give Without Being Taxed?
Regarding the gift tax, you can give $16,000 in value tax-free to as many people as you’d like during 2022. They do not need to be a family member or otherwise related to you. Unknown strangers would qualify. By the way, in case the recipient asks, they will not have any federal tax liability on the gift either.
Typically, large gifts would go to a family member, so I will use that as the backdrop for an illustrative example. Let’s say that Johann has 4 nephews and 3 nieces. He can give each one $16,000, all at once or split it up into a few checks for the year 2022. Thus, he will have given $112,000 tax-free in 2022.
If you give more than that amount, it will be tax-free if it qualifies under the lifetime exemption. That will reduce that lifetime exemption amount so that when the estate passes, the amount that is taxed will be higher. If Johann gave each nephew and niece $1,016,000, he would have $5.06 million left of his $12.06 million dollar lifetime exemption.
The US Congress increased the gift tax exclusion amount in the Tax Act of 2017. The exclusion amount is scheduled to drop down to pre-2018 levels after 2025. In 2022, as an individual, you can give $16,000 without being taxed. You and your spouse can give $32,000 together, up from $30,000 in 2021. The gift tax return is due April 15th following the year in which the gift is made. Under current federal law, the estate and gift tax exemption is $12.06 million per person, up from $11.7 million last year.
What is the Future of this Exemption?
Last year, two U.S. Senators introduced legislation that would change the federal estate and gift taxes. It would have reduced the estate exemption from $11.7 million to $3.5 million and the gift tax exemption from $11.7 million to $1 million. For more information, see our blog post on Understanding How the 99.5% Act Affects You. It appears that that legislation is stalled out, but it could always be reintroduced. That is one reason that is better for donors to act sooner rather than later. To read more about the 2017 legislation, we have a blog post at No Clawbacks. The Time to Act is Now! The lifetime exemption is slated to return to a $5 million base after 2025.
Other Methods to avoid the Gift Tax Exemption.
If you are giving more than $16,000 to an individual and do not want to reduce your lifetime exemption, there are a few methods available.
They are more complicated than a gift tax return, and beyond the scope of this blogpost (please email or call us if you’d like us to cover them or something else in a future post).
They include the use of a Crummey power, which enables a person to receive something of value that is not eligible at that time for the exclusion and later convert it into a gift that is eligible. This is often used by parents to shelter their funds while providing lifetime gifts to their heirs. They are mentioned, for example, in this recent Forbes article, The Three Ways To Make Tax-Free Gifts And Why You Should Use Them Soon.
Another method to avoid the gift tax is through gifting shares of an LLC, without management or voting rights, which makes them less marketable. The shares will still be taxed but at a lower value. Estate planning is challenging enough, so be sure to consult with competent counsel before attempting to form a family-owned LLC. It will provide significant tax benefits for large estates, though the regulatory framework requires some experience.
As you can see, there are huge amounts at stake and a shifting legal tax landscape to negotiate. Our advice is to act soon and with experienced advisors.
Here to Help
The trusted estate planning attorneys at Lowthorp, Richards, McMillan, Miller & Templeman are here to provide legal assistance. We know what it takes to successfully plan for the future, and we truly care about what is most important to you. Together, we will evaluate your assets, discuss your goals, and work to prepare, provide, and implement estate planning options that best serve you and your family. If you are interested in taking advantage of the increased gift tax and estate benefits provided by the Tax Cuts and Jobs Act of 2017, let us lead the way. For more information, we invite you to visit our website, or call us at 805-981-8555. When the window of opportunity opens, we will make sure you and your family reap the benefits.