The Gift Tax: The Ultimate Guide

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Paul Sundin, CPA

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The gift tax will apply to any property transfer by gift, whether made directly or indirectly and whether made in trust or otherwise. A transfer is a transaction where the property is passed to or conferred upon another regardless of the means or device employed. Gift taxes were not repealed in 2010.

Gifting is a method of reducing or eliminating growth in estate value and consequent future potential estate tax liability. Each completed gift made over a donor’s lifetime removes the current value of the property gifted from the estate and any appreciation in the property. However, there is a price to pay for making gifts.

This price is the federal gift tax. This tax has two purposes: (1) To discourage the avoidance of federal income taxes by giving away income-producing assets to those in lower-income tax brackets, and (2) To limit avoidance of federal estate taxes by lifetime gifts that remove property from the donor’s estate.

The current gift tax had its roots in the Revenue Act of 1932 and persists today in §2501 through §2524. Gift Tax Computation lifetime gifts and transfers at death are taxed on a tax schedule with cumulatively progressive rates. Each taxable transfer, including the final transfer at death, begins in the tax bracket attained by the prior gift. For gifts made in 2010, the applicable exclusion amount for gift tax purposes was $1 million, and the gift tax rate was 35%.

However, for gifts made after December 31, 2010, the gift tax was reunified with the estate tax, with the same applicable exclusion amount of $11.58 million (in 2020) and a top gift tax rate which has risen from 35% to 40% for transfers that exceed this exclusion. Note: The applicable exclusion amount can be used during lifetime or at death, not both. Calculation Steps The following schedule is an outline of the basic gift tax calculation steps:

Selecting Gift Property

The following factors should be considered when selecting gift property:

  1. If property in excess of the annual exclusion is transferred and the primary reason for the transfer is to reduce estate taxes, the donor should transfer property with a low gift value relative to estate value (i.e., property with a high appreciation potential).
  2. When the property will be sold by the donee, highly appreciated property may not be a good selection, since large capital gains may be incurred by the donee. In addition, if retained by the owner, the property should obtain a full step-up in basis at death.
  3. If one of the objectives of the gift is to transfer income to a lower income tax bracket, high-yielding income property would be appropriate.
  4. Property that may present problems of valuation, division, or sale for the personal representative of the estate should be considered. For instance, art objects, antiques, and jewelry are apt to be good for lifetime giving, since they often present valuation problems. In addition, there are sometimes questions as to whether they are to be sold or retained, and if retained, to whom they should be given if not the subject of a specific legacy.
  5. Assets that shrink in value with age such as copyrights, patents, leaseholds, mineral rights, and the like are not usually good for gifts. These are known as shrinking or wasting assets.

Gift Advantages

  1. $15,000 (in 2020) may be transferred free of any transfer tax to any donee, each and every year; the amount may be $30,000 if spouses join in the gifts.
  2. The future growth in the value of property given away can be removed from the donor’s estate and be transferred to the donee. Better to pay transfer taxes at the lower current value, rather than at the higher value that will exist at the time of death.
  3. Giving income-producing property shifts the income tax consequences from the donor to the donee, who may be in a substantially lower income tax bracket. The income tax savings occur each year, and so the beneficial effect will be cumulative over the donor’s lifetime.
  4. Gifts from one spouse to the other are completely free of gift tax (§1041). 5. Giving low basis property to a spouse or other person who may die before the donor, and who wills the property back to the donor can sometimes qualify that property for basis advantages. 6. In a community property state, a gift of low basis separate property to the community (a gift of one-half to the non-owning spouse) may ensure that upon the death of either spouse, the entire property will qualify for basis advantages.
  5. Gifts may adjust the ownership percentages among the component parts of an owner’s estate, perhaps making it possible to qualify for long-term installment payments of estate taxes, or for §303 redemptions to pay death taxes and expenses.
  6. Gift payments of medical and tuition expenses for a donee are gift tax-free.2-73

Gift Disadvantages

  1. Donor loses control over, and income from, the property given away. It is therefore not available for his or her future security, or to meet unexpected emergencies. In an uncertain world, this could be disastrous.
  2. Gifts can make the donee wealthier than the donor, thus making the ultimate tax burdens even higher, and shifting the obligation to pay those taxes from the donor to the donee.
  3. Gifts can have an adverse effect on the donee’s personality, his or her family relationships, and his or her attitudes toward life. They could conceivably turn the donee into a sloth. They might cause a rift in his or her marriage or other personal relationships.
  4. Gifts to a minor child, where the minor gets his or her hands on the property before he or she has reached financial maturity, are potentially the most dangerous of all. In the hands of a normally rebellious teenager, they could break his or her relationship with his or her own parents.
  5. Even though the list of disadvantages is not as long as that of advantages that does not mean that the disadvantages might not be the most important, and might not tip the scales in favor of not making a contemplated gift.
  6. Weigh the disadvantages very carefully before making any gift that is motivated solely by potential tax savings.

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Estate CPA

Gilbert, AZ