hile many taxpayers know about the $10,000 annual gift tax exclusion, they do not realize it can be one of the most effective techniques available for providing substantial long-term tax savings. In addition to lowering current taxes, it can be used to move assets out of a taxable estate on a discounted basis and to remove future value from a taxpayer’s estate.
Annual exclusion amount. Taxpayers may make annual gifts of up to $10,000 per donee, with no limit on the number or relationship of donees. The gift must be of a “present interest in property,” which means an unrestricted right to immediately use or enjoy the property (or income from the property). Gifts covered by the annual exclusion do not reduce a donor’s $675,000 unified tax credit.
Purposeful gifting. Sometimes a taxpayer is unwilling to make gifts because potential donees have not used money properly in the past or the taxpayer wishes to delay their access to the gift’s benefits. Parents in this situation can make annual exclusion gifts to minors who qualify for Roth IRAs. The parent will control the funds as the minor’s guardian. (Obviously, the parent will lose direct control over such funds when the child reaches his or her majority.)
Another alternative may be to use family limited partnerships or trusts to limit family members’ access to funds.
Deathbed gifts. “Deathbed” annual exclusion gifts are a significant planning tool. However, if a donor dies before a gift check clears his or her account, the gift amount is includible in the donor’s estate. Note: A charitable deathbed check does not need to clear to be a valid gift.
Tuition and medical gifts. In addition to the annual exclusion, amounts paid on behalf of an individual for education, training or medical care are not subject to gift tax. Thus, parents and grandparents should consider making gifts of tuition and medical costs for family members without reducing the annual exclusion or unified credit.
The payments should be made directly to the qualifying medical or educational provider. The tuition exception does not apply to amounts paid for room, board, books or supplies. The medical expense exclusion does not apply to amounts reimbursed by insurance.
Unless the donee is the donor’s dependent, the donor will not be entitled to an income tax deduction for payment of medical expenses; however, these payments qualify for the gift tax exclusion without regard to the parties’ relationship. Caveat: Payment of these gifts could be taxable income to a parent who is obligated to provide such support.
Gifts of prepaid tuition also may be made to certain qualified state tuition programs. These gifts do not come under the medical or educational gift exclusion and would be covered by the annual exclusion or the unified credit.
Gift-splitting. A spouse may elect to be treated as the donor of a gift although the other spouse is the sole transferor. For gift-splitting to apply, the donor must file a gift tax return on which the spouse consents to treat gifts as made half by each. Gift-splitting, if elected, applies to all gifts made during the year, and not on a gift-by-gift basis.
Basis issues. In general, a donee takes the donor’s basis in any assets given. However, if the asset’s basis exceeds its fair market value (FMV), for loss purposes the donee takes the FMV. Thus, if the basis of an asset exceeds its FMV on the date a gift is made and the donee subsequently sells the asset for a gain, he or she uses the donee’s basis in determining gain; any appreciation in the asset’s value will be taxed to the donee. If the asset is sold for a loss, the asset’s basis is its FMV on the date of the gift.
For discussion of strategies in this area, see “Effectively Using the Annual Gift Tax Exclusion (Part I),” by John Scroggin, in the June 2001 issue of The Tax Adviser.
—Nicholas Fiore, editor
The Tax Adviser