Posts Tagged ‘gift tax’

Why You Aren’t Really Limited to $14,000 in Gifts Each Year

APRIL 27, 2015 VOLUME 22 NUMBER 16

There is so much misinformation (and misunderstanding) around gift taxes, that we thought we would take a few moments and try to straighten out the confusion. Let’s start at the end: if you live in Arizona, and are not fabulously wealthy, you probably don’t actually care very much about gift taxes. Now let us explain why.

Arizona doesn’t assess any gift tax, estate tax or inheritance tax, so those of us living in The Valentine State only have to understand federal estate and gift tax systems — unless, of course, we own property in one of the states that does impose a tax on such transfers. Meanwhile, a basic understanding of the federal gift tax is practically embedded in our DNA: you can make a gift of up to $14,000 per year, but anything over that is prohibited.

The problem with that basic understanding is that it is wrong. The magical $14,000 figure is just the number that Congress has set as being too small to even bother thinking about. Nonetheless, it has a strong hold on the public imagination — even though the number has only been set at $14,000 since 2013. The “don’t even think about it” number was $3,000 for four decades before rising to $10,000 in 1982; it started increasing in $1,000 increments in 2002 and will probably rise to $15,000 within the next couple of years.

In calculating whether you have made gifts of over $14,000, by the way, the federal government gives you three important additional benefits:

  1. The $14,000 figure applies to gifts to each person, not the total amount of gifts in a year. Do you have three children you want to make gifts to? No problem. You can give each of them $14,000 this year, for a total of $42,000, without having reached the threshold.
  2. Are you married? It’s simple to double the numbers — even if you (or your spouse) are actually making the full amount of the gift. A married couple can give away $28,000 without having to do anything more (though if all the money comes from one spouse there is one more step required — more about that later).
  3. Will the gifts be used for medical or educational expenses? The lid just got taken off. So long as you make your gifts by paying directly to the college, or hospital, or other provider, there is no $14,000 limit. You can pay your favorite granddaughter’s tuition and books directly, and still give her another $14,000 (double that if you’re married) without having to do another thing.

Does all that mean you are generally limited to giving $14,000 (each) to each recipient? No. That’s just the level below which you don’t have to do anything else but sign a nice card and make a notation in your check register. Want to make a $50,000 gift to your son, or your daughter, or your mailman’s nephew? No problem — you’re just going to have to file a gift tax return.

That sounds scary, but it’s really not. You won’t actually pay any gift tax unless the total amount you give away (over and above the $14,000 + tuition + medical expenses each year) exceeds $5.43 million dollars in your lifetime. And even that number is going up each year.

The bottom line: if you live in Arizona, don’t own property in a state that imposes a gift tax, and are worth less than about $5 million, you are simply going to be unable to pay a gift tax over your entire life, no matter how hard you try. That is also true, by the way, for estate taxes — you are going to have a very hard time incurring an estate tax in those facts, even if you want to do so.

So imagine that you want to make that $50,000 gift to one person (or two $50,000 gifts, or three) in 2015. How hard will it be to prepare and file the gift tax return? Not very. If you ask your tax preparer to do it for you, we predict that you will get charged a couple hundred dollars. You can almost certainly figure out how to file it yourself — just look for information about the federal Form 709. Things can get a little more complicated if you are giving away an interest in your business, or a fraction of a larger asset — you really will need to get professional help in such a case. But there’s no rule that says you simply can’t give away more than $14,000, or that you’ll pay any taxes or penalties if you go over that amount.

By the way, there’s a common misconception about other tax effects of gifts, too. There is no income tax deduction or adjustment for your gifts, and the recipient pays no gift tax on receipt of the gift. Of course, if you give away an income-producing asset the future income will be taxed to the new owner, but the only immediate tax effect of a gift in Arizona is the (almost nonexistent) federal gift tax.

Does all this mean we advocate making large gifts? Not necessarily. There are some secondary tax consequences of giving away larger assets — especially those that have appreciated in value while you owned them. Before making a gift of real property, or appreciated stocks, get good legal and tax advice. And there are plenty of non-tax reasons you might not want to give away a significant portion of your assets. But the federal gift tax shouldn’t be much of a disincentive for most people.

Gift Tax Limit Will Rise to $14,000 in 2013

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:

  1. 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.
  2. 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.

Disclaimer Ineffective When Signed After Accepting Benefit of Property

A recent Arizona appellate court decision gives us an excuse (not that we really needed one) to write about an arcane planning technique: disclaimer. How do you disclaim an interest in property, and why might you want to? We’ll see if we can give you an introduction to the concepts. Warning, though: this will be brief, and Arizona-specific. If you have a real-world question, talk to a lawyer in your jurisdiction.

When J. Scott Gardner died in Phoenix in 2008, he left a house in the Prescott area. The house had a $205,330 mortgage; Mary Richards (not her real name) lived there. Mr. Gardner’s trust directed that Ms. Richards should be able to live in the house, provided that she pay all taxes, utilities, homeowners association fees and insurance. She was also to pay “any other reasonable and customary fees that would normally accompany a property.”

The trust directed that when Ms. Richards died, Mr. Gardner’s two children would take ownership of the house. Mr. Gardner’s brother was named as trustee of the trust.

The trustee’s first question arose pretty quickly. Who was to pay the mortgage payments on the house while Ms. Richards lived there? He turned to the local probate court for instructions; the judge ruled that Ms. Richards should pay the interest on the mortgage, and the two children could pay the principal amounts due on each payment (since principal reduction on the mortgage would ultimately flow to their benefit).

Now a second problem arose. Mr. Gardner had died just before real estate values all across Arizona declined steeply, and everyone agreed that the house was no longer worth the amount of the mortgage. Ms. Richards had asserted her right to use of the house in correspondence among the parties, but had not paid the interest payments even after the probate court directed that they were her responsibility. In May, 2010 — a year and a half after Mr. Gardner’s death and Ms. Richards’ assertion of her interest in the property — she sent the trustee a letter attempting to disclaim her interest.

Why would she do that? The appellate decision does not deal with the parties’ strategy, but it is fairly easy to deduce her reasoning. If she was held to have taken possession of the house, then any money she was entitled to receive from the rest of Mr. Gardner’s trust estate would be reduced by the unpaid interest — and that interest debt would continue to accrue until the property was disposed of. Since there would likely be no net return from the sale of the house, that would mean that her inheritance was being reduced by the amount of the interest payment each month.

It doesn’t actually matter to the legal issue, but you probably are wondering what happened to the house. The trustee asked the probate court for permission to stop making any payments on the mortgage. The judge agreed that it made no economic sense to keep paying on a house with no equity, or even a negative equity, and so payments were stopped. The mortgage holder repossessed the property. But the legal problem remained: did Ms. Richards owe the trust the unpaid interest payments?

The probate court decided (and the Arizona Court of Appeals agreed) that Ms. Richards’ attempted disclaimer was invalid. To be valid under Arizona law, a disclaimer of a bequest or inheritance must be in writing, signed by the person disclaiming, and delivered (or recorded) according to the statute. If all those conditions are met, then the disclaimer can be effective — and it has the effect of causing the disclaimed person to be treated as if they had died before the person transferring the property to them.

There are two other important rules, though, and one of those tripped up Ms. Richards. A person can not disclaim property after they have already accepted it — or received the benefit of the property. Since Ms. Richards had possession of the Prescott house, knew of her liability for payment of expenses and asserted her interest in letters she wrote to the trustee, she could no longer disclaim her life estate.Estate of Gardner, August 9, 2012.

The other “rule” about disclaimers, widely understood, is actually a little bit trickier. Most lawyers, when asked about disclaimers, will recite the requirement that any disclaimer must be completed within nine months of the date on which the property interest would have passed (ordinarily, the date of death of the person leaving the property to the disclaimant). That is actually a requirement of federal tax law — in order to receive favorable tax treatment a disclaimer must be within that time limit. Some states have also adopted that nine-month limitation for all disclaimers, but Arizona has not. A disclaimer within the nine months is usually said to be a “qualified” disclaimer — a disclaimer that is otherwise valid under Arizona law but not qualified for favorable tax treatment is, unsurprisingly, known as a “non-qualified” disclaimer.

All that begs the question we began with: why would anyone want to disclaim the inheritance or gift they were set to receive? There are lots of reasons. A few of the more common ones we see:

  • The recipient has a very large estate, and is happy to have the inheritance pass on down to (usually) the next generation — perhaps to keep from having a large estate tax on their own estate, or perhaps just because they don’t want or need the inheritance.
  • The recipient has a lot of debt, and creditors standing ready to seize any property they might inherit. By disclaiming, the intended recipient can allow the property to get to the next recipient without being subject to those creditors’ claims.
  • The recipient does not feel deserving of the gift. Perhaps the decedent’s will or trust was written years earlier, when the recipient and the decedent were close friends or business associates — or romantically involved. The recipient might feel uncomfortable taking the property after a long estrangement, and recognize that the only reason the decedent didn’t make changes in his or her will or trust was the ordinary inertia that sometimes overcomes people faced with estate planning decisions.
  • The alternate beneficiary is particularly well-suited to handle the property. Perhaps it is a well-crafted special needs trust benefiting a close family member, or a charitable organization set up to deal with the property in question. The recipient might decide to just let the next person or entity in line deal with the inheritance.
  • Perhaps the property is more of a liability than a benefit — as turned out to be the case for Ms. Richards. We have seen other cases where the property subject to the inheritance was tainted by pollutants, or subject to a big property tax liability.

One key thing to understand about disclaimer: if you sign an effective disclaimer, you have no control over where the property goes. You can not disclaim “to” another person. When you disclaim, the property passes as if you had predeceased the donor; that might be to someone (or some entity) you don’t like or don’t approve of. If that troubles you, disclaimer might not be for you. The only way to control where the property goes is to accept the inheritance and then make a gift yourself — and that might involve creditor claim issues, estate tax issues or even gift tax issues. Get good legal advice. But at least now you’ll be a little bit familiar with the concepts.

New Tax Law Will Mean More Planning Is Necessary, Not Less

JUNE 18, 2001 VOLUME 8, NUMBER 51

Last week Elder Law Issues predicted that the principal effect of the federal government’s estate tax repeal would be to make most people revisit their estate plans (and their attorney) more often. Because of the automatic “sunset” of the repeal measure in 2011, any plan addressing the changes in estate taxes must also deal with the real possibility that the tax will be reinstated in ten years. Even if the repeal becomes fully effective the imposition of a system of “carry-over basis” will mean that wealthy individuals still need to plan for taxes imposed on their heirs.

Not surprisingly, the new tax law is considerably more complicated than even those changes. A number of other provisions affect individual estate plans, and not all of those have been widely discussed or explained. Among the other changes in the new tax law:

The generation-skipping tax (usually referred to as the GST) will be reduced and, ultimately, eliminated. Current law imposes an additional tax on some property left to grandchildren and other younger beneficiaries. There is an exemption as to the first $1,060,000 left to later generations: that exemption will begin to increase with the estate tax exemption itself in 2004. Until that time the current maximum (adjusted annually for inflation) applies.
Current estate tax law allows some owner of family businesses to pass a larger amount to their heirs without incurring estate taxes. Although it can be difficult to qualify for the favorable treatment, at least some small business owners can take advantage of the so-called QFOBI (“Qualified Family Owned Business Interests”) rules to pass a total of up to $1.35 million without estate taxes. That special deduction for family business owners will end after 2003.
Limits on contributions to retirement accounts will increase in steps beginning in 2002. Not everyone can pay in to IRA and 401(k) plans. Those who can will find that maximum IRA contributions increase to $3,000 in 2002, to $4,000 in 2005 and to $5,000 in 2008. 401(k) limits (now set at $10,500) increase to $11,000 in 2002 and by an additional $1,000 each year until 2006 (when the limit will have reached $15,000). Contribution limits are raised for other, less-common retirement plans as well.
Gift taxes are not scheduled for repeal. Although the current transfer tax system treats lifetime gifts and transfers at death in a unified approach, that relationship diminishes next year and ends in 2010. After 2002, gifts of more than $1 million will be subject to the gift tax even though there might not be any estate tax if the property had been held until the owner’s death.

What do all the estate, gift and income tax changes mean? Most people will need to reconsider their current estate plan now, and at least once again as the 2011 deadline draws near.

What Estate Tax Repeal Means For Most Taxpayers: Not Much

JUNE 11, 2001 VOLUME 8, NUMBER 50

On June 7, 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001. Despite extensive media coverage of tax reform, and especially of estate tax repeal, over the past six months, you may have been left wondering what it means. It turns out that it doesn’t mean much for most of us.

Estate tax repeal will have one of two effects for most people. For some, the change in tax laws will mean they must spend more on lawyer’s fees for changes to their estate plans—and may have to make more than one set of changes as the rules slowly shift over the next decade. For most people, however, the principal effect of estate tax repeal will be felt when government revenue must be raised from some other source—possibly including taxes on middle class citizens who wouldn’t have paid estate taxes under the old rules.

There are four elements of estate tax repeal that make it difficult to predict exactly what will happen over upcoming months and years:

Reductions in the estate tax will be phased in over a ten-year period, with relatively little change before full repeal. The current $675,000 exemption from federal estate tax liability is raised to $1 million next year and then increases slowly, but it only reaches $3.5 million before repeal.
The top tax rate drops slightly each year, from the current 55% to 45% in the year before the tax is finally eliminated.
Upon repeal of the estate tax, a new system of taxation is imposed—heirs will pay income taxes on capital gains when they sell inherited property. There will, however, be a substantial exclusion from this new tax—$1,300,000 of gain for every decedent’s estate, and another $3,000,000 of gain for surviving spouses.
Estate tax repeal is itself repealed in 2011.

That’s right: as currently written, the law ending the estate tax in 2010 ends (and the estate tax returns) in 2011. Authors of the tax repeal measure insist that they only included that provision in order to “balance” the budget for the next decade, but real estate tax repeal will require another Congress and President to sign another bill sometime in the next decade.

The new law eventually eliminates the “generation-skipping” tax, which penalized transfers to grandchildren (although a $1 million exemption makes the penalty less onerous). The gift tax, however, remains in effect—to keep taxpayers from giving their property to terminally ill family members expecting to get the property back within a few years.

Meanwhile, no one dares predict how federal estate tax “repeal” will affect state governments, where the estate tax has been a major source of revenue for decades. Arizona, for example, received about $80 million from the state estate tax last year. The federal credit for payment of state taxes will be phased out starting in 2002, so that the effect of estate tax reductions will be smaller—unless states follow the federal governments’ lead.

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