NOVEMBER 19, 2012 VOLUME 19 NUMBER 42
Here's the headline: the annual gift tax exclusion amount, which has been set at $13,000 per year since 2009, will increase next year by $1,000. That means you can give up to the higher figure ($14,000) to any one other person without having to file a federal gift tax return.
This confuses people, though it's not really that complicated. Let's take a shot at simplifying it.
The U.S. government imposes a tax on substantial gifts. It does that partly to protect the estate tax -- if it was easy to just give away all your assets during your life, no one would ever be liable for an estate tax. But the government is not interested in making everyone file gift tax returns for the wool stocking cap and slippers you plan on giving your aunt for Christmas this year, so it has a threshold amount it ignores. In fact, that amount was well over the stocking cap and slippers in 1997, the last time Congress tinkered with it.
That year you could give $10,000 in a year. Your spouse could give another $10,000 (in fact, you could give $20,000 and just say half was from your spouse). Congress decided that figure ought to be adjusted each year for inflation, but no one relished having to remember that in 1998 the figure was $10,257 or some such number -- so they set it to increase only in $1,000 increments. The first time it actually increased (to $11,000) was in 2002. It's been at $13,000 since 2009, and next year it will go up to $14,000.
Here's the confusing part, at least for most people: it doesn't mean that you can't give more than $14,000 (next year) to someone. It doesn't even mean that you'll pay a tax if you do. It just means that if you give more than $14,000 to one person, you will have to file a gift tax return. No tax will be due until the total amount of gifts in your lifetime exceeds -- well, this is another confusing part of the story. Let's just say, for now, that all the gifts in excess of the applicable annual exclusion amount each year must total $1 million over your lifetime before you owe any gift tax.
You may have read that the actual figure for 2013 (the amount you have to give away, in excess of your annual exclusion amounts) is $5.12 million. That figure is scheduled to revert to $1 million next year. Nearly everyone who follows these things expects Congress to change the $1 million figure to something larger, though it is unclear what the final figure might be. No one is sure when that change will be finalized, though few expect Congress to act before December 31 of this year.
Does that mean that the $14,000 figure is unsettled? No, it does not. This scheduled increase in the annual gift tax exclusion amount is independent of the tax cuts scheduled to expire next year, and is unlikely to be changed by Congress even if it does act on the larger tax questions.
Many people, and many tax advisers, have counseled wealthy individuals that they ought to consider making substantial gifts before the scheduled reversion to (approximately) 2002 tax levels. For people worth substantially more than $1 million, and especially for those worth well over $5 million, that is probably good advice. But for most people, the increase in the gift tax exclusion figure -- the new $14,000 number -- is actually more important. It allows the modestly wealthy to make larger lifetime gifts without worrying very much about gift taxes or the prospect of estate taxes.
Let us assume, for a moment, that you are in your sixties or seventies, that you have three adult children and six grandchildren, that you are married, and that you and your spouse are worth $1.5 million. Should you hurry and give away most of your money before the end of 2012? Probably not, as you are likely to be uncomfortable with the prospect of not having complete control over your money for the next decade or two.
That is especially true starting next year, when you and your spouse can give $28,000 per year to each of your children (and, if you are so inclined, another $28,000 to each of their spouses). On top of that, you can give $28,000 to each of your six grandchildren each year. If you feel the need to reduce the size of your estate to below the $1 million taxation level, you can give away over $250,000 without even having to file a tax return -- much less pay any tax. You have quite a few years left to accomplish that goal, and you can probably wait to see what Congress does before making any rash decisions.
Your circumstances will almost certainly vary, of course, and that is what good legal advice is all about. You should discuss your individual situation with your estate planning attorney to determine the best course of action for you. But the increase in the annual gift tax exclusion amount gives you just a little more flexibility as you make your plans.
There are at least two other points we should make about the gift tax rules before we leave the subject:
- Arizona does not have a gift tax (or, for that matter, an estate tax) at all. If you live and die in Arizona, and all your property is here, you simply do not have to worry about state taxes on the transfer of your wealth to your children or other beneficiaries.
- The gift tax exclusion is not the only way you can make tax-free gifts. You can also pay for medical and education costs (you have to pay directly, not just make a gift to one of your children earmarked for college, for example). You can also make charitable gifts without worrying about the limit (your charitable gifts may also give you some income tax breaks, but that is a completely different story).
We hope that helps you understand the gift tax system. We plan on providing updates on the estate tax changes we expect to see over the next few months; stay tuned for the next wave of complications. But we think it pretty likely that this small scheduled change will actually be more important to most readers than what Congress does with the estate and gift tax system.