Using the annual exclusion gift is a powerful and tax-efficient option for gifting.
Most would agree that the old adage is true — it is better to give than receive. Being at the point in your life where you have the ability and willingness to share your wealth with others can be very rewarding. However, before you provide a gift, whether it is to a child, grandchild or a charitable organization, there are some things to consider.
Many of our clients often ask for our advice regarding the best ways to give to their children or grandchildren without having to pay an unexpected tax bill. Each situation is different, so the best way to give depends on your intention.
This article will touch on some of the more common approaches you can take.
To explain, let’s start with some definitions. A person who gifts property to another person or entity is known as a “donor.” Whereas the recipient of a gift is known as the “donee.”
Regardless of how you decide to give, there are some gift tax implications to be aware of. In 2022, a donor can give up to $16,000 gift-tax free to an unlimited number of donees. They can be family members, friends or neighbors. This is known as making an “annual exclusion” gift.
Annual exclusion gifts can be a powerful, but simple tool. Some of the benefits to the donor include:
- No gift tax will be due.
- Gift tax reporting will not be required.
- It can reduce the donor’s taxable estate.
If you are married, you can double the gift up to $32,000 annually per donee utilizing a technique called “gift splitting.” Gift splitting does require that the donor report to the IRS in the year it is done.
For most people, if a gift exceeds the annual exclusion amount, it simply means that you have an obligation to report that gift to the IRS. You will not have to pay a gift tax unless you have given away more than your lifetime exemption limit, which currently is $12,060,000.
There are numerous ways to give to your family and friends, and depending on your gift’s purpose, some strategies will work better than others. Let’s take a look at some different ways to give.
The gift tax annual exclusion amount per donee for 2022 is $16,000 for gifts made by an individual, and $32,000 for gifts made by a married couple.
Common Gifting Strategies
Below are some common techniques to consider:
- Make annual exclusion gifts of up to $16,000 (discussed above).
- Make tax-free medical gifts if the payment is made directly to a medical service provider for a person’s medical care. This type of gift is not limited to the sum of $16,000.
- Make tax-free educational gifts if the payment is made directly to a college or school for a person’s education. This type of gift is also not limited to $16,000 and does not use any of your gift or estate tax exemption.
- Make contributions to a 529 College Savings Plan. This permits the money contributed to the plan to grow free of federal income taxes. Additionally, withdrawals are also income tax free if used for qualified expenses. Donors can frontload a 529 Plan with five years’ worth of annual exclusion gifts for a total contribution of $80,000 per donee.
- Make gifts to minors via a Uniform Gifts to Minor Act account. A custodian holds title and has control of the UTMA account for the benefit of a minor until they reach of age of majority (18–21 years of age depending on state regulations). For income tax purposes, the assets held in a UTMA account are treated as owned by the child, so earnings are typically taxed at the child’s lower income tax rate.
Another important idea to understand is that when you choose to give money, you are letting go of it. A “gift” has no strings attached. If you have specific intentions for how you would like gifted funds to be used, then you should explore creating a trust.
529 Plans can be used for K-12 education expenses and higher-education expenses.
For a variety of reasons, creating a trust can be a better option than making an outright gift. Trusts give the donor control over how and when funds are distributed and may also provide additional tax benefits. Gifts in trust can be beneficial for relatives who may not be financially responsible or when giving to younger children or grandchildren.
Trusts are traditionally used as an estate planning tool to distribute inheritance, but they can also be used as a gifting strategy to your family while you’re still alive. There are many different types of trusts, and we can help you decide on the best option.
If you have specific intentions for how you would like gifted funds to be sued, then you should explore creating a trust.
Type of Assets to Give
While almost any type of asset can be gifted (real estate, jewelry, artwork, etc.), the most common is still cash. It is the easiest and cleanest way to give. Cash also gives your recipient complete freedom as to how it’s spent.
Another great option for giving to your child is to gift stock, which has some significant benefits. Stocks have historically outperformed cash, as they continue to appreciate until the recipient decides to sell. If you trust your kids to leave the funds untouched, or if you intend for this gift to be a learning experience to help them understand investing better, then gifting stocks is a great option.
Although there are benefits to gifting stock, there are a few considerations to keep in mind. First, the value of the stock gift is the fair market value at the time the gift is given. Second, the $16,000 annual exclusion amount applies to gifts of stock as well, and should be a consideration in determining the amount and timing of such a gift. Third, it’s important to remember that stocks are only worth what they are selling for at that particular time. They will appreciate or depreciate according to the market. Finally, if the recipient decides to sell the stock, this could result in capital gains or losses. This could create tax implications, because the recipient of the gift receives the donor’s cost basis in the stock (what the donor originally purchased the stock for). This is why we recommend working with Trust Point to determine if this is the best option for your situation.
Giving a “Gift” to Charity
We have several clients who want to do good with their wealth and are interested in giving “gifts” or donations to charitable causes that they care about. One of the most powerful ways is through a Qualified Charitable Distribution or QCD.
Clients who are at least 70 ½ years old can make a QCD from their IRA. The QCD will not be taxed on amounts up to $100,000 annually per taxpayer. If you are subject to Required Minimum Distributions (RMDs), you can use a QCD to satisfy your RMD. QCDs require a direct payment from the IRA to a qualified charity.
An additional benefit is that the QCD excludes the amount donated from inclusion in your taxable income, which is unlike regular withdrawals from an IRA. Keeping your taxable income lower may reduce income taxes on your Social Security benefits and income-related monthly adjusted amounts for Part B and Part D Medicare. Finally, QCDs don’t require that you itemize, so you may take advantage of the higher standard deduction, but still use a QCD for charitable giving.
Visit our charitable giving page to learn more about the charity-based financial services Trust Point offers.
Most individuals who are financially able to give do so to support those they love and care about. Overall, if you are in the position to give, there really isn’t a wrong option. Consider who you are giving to, the purpose of your gift and if there are tax benefits or considerations.