For most people, federal estate and gift taxes are not a concern. The reason is because there is a lifetime credit that can be used against either taxable gifts made during one’s lifetime or against federal estate tax at the time of death.
Since 2010, the credit has increased from $3.5 million to $5 million with an annual cost of living adjustment each January. Currently, the credit is $5.45 million ($5.49 million starting Jan. 1). As a result of this large increase in exemption, many people no longer have to worry about estate and gift tax issues. However, for those people who do have larger estates, planning is still needed.
There is also an annual gift tax exclusion that allows any person to give up to $14,000 to another individual in any calendar year without having to report the gift to the Internal Revenue Service. The annual exclusion started at $10,000 and has been increasing by a cost of living adjustment, but only in $1,000 increments. This year, and in 2017, the annual exclusion amount is $14,000. Eventually, with cost of living adjustments, it will move to $15,000 per year.
For example, if a person gives $20,000 to another individual in a calendar year, the person making the gift has in essence made a $6,000 taxable gift. The gift is tax-free to the recipient of the gift. The donor is responsible for filing a federal gift tax return (Form 709) to report the $6,000 taxable gift. The donor will not actually pay a tax at that point because the donor has his or her lifetime estate and gift tax exemption to apply to any taxable gifts. Very wealthy clients who give more taxable gifts than their lifetime exemption amount would have to pay a gift tax.
Wealthy individuals may wish to reduce the size of their estates by making annual gifts to reduce or avoid federal estate taxes upon death. However, it is important to note that in order for the $14,000 annual gift tax exclusion to apply for the year of the gift, the donee receiving the gift must cash or deposit the check in that same year. For example, a donor who is very ill and wishes to make gifts to reduce the size of his or her estate toward the end of a calendar year may write checks to make gifts to children or grandchildren or other individuals. It is important for those individuals receiving the checks to cash them before the end of the calendar year in order for them to count against the donor’s annual exclusions for that calendar year. If a donor has used up his or her lifetime exemption and writes a check to a donee for $14,000 in December 2016 and the donee waits to cash the check until January 2017, and then the donor makes an additional $14,000 gift in 2017 to the donee, the donor will owe gift tax of $5,600 as a result of the donee’s delay.
The analysis is different if the donor is writing checks to charitable organizations. In that case, the gift is effective to reduce the size of the donor’s estate and provide the donor with a charitable income tax deduction for that year, as long as the check is written and delivered or mailed to the charity before the end of the calendar year.