Few topics generate as many questions as the subject of gifts and gift taxes. Perhaps the reason lies in the tendency to treat the subject either far too casually or to examine obscure issues having little interest to the client. In this article we will attempt to review the rules applicable to gifts and gift taxes as they apply to you.
When is a Gift a Gift?
The first problem in dealing with gifts is to determine when you have actually made a gift. The elements of a gift are simple.
Intent to make a gift.
Delivery of the gifted property to the donee.
Acceptance of the gifted property by the donee.
Intent to make a gift seems obvious. Either you intend to make a gift or you do not. The subjective intent of the donor does not count. It is not that simple. Many gifts are made without the realization that a gift has occurred. A parent makes a loan to a child and forgives the loan. That is a gift. A parent sells assets to a child at a greatly reduced value. The difference between the sale price and the fair market value of the assets sold is a gift. Any time you relinquish dominion and control over an asset without consideration, you have made a gift. For instance, placing your children’s name on your home constitutes a completed gift.
Assume Jack has a home worth $300,000. He executes a deed transferring the home to himself, and to his daughters, Mary and Sue. Jack can no longer sell the house without the approval of Mary and Sue. He has gifted one-third of the house to each of the two daughters. He has made a gift of $200,000.
Delivery and Acceptance
The second and third elements of a completed gift, delivery and acceptance, are treated together. As stated above, executing a deed placing the daughters’ names on the home constitutes a gift. The deed is delivered, recorded and the gift is deemed to be accepted.
On the other hand, consider the case where mother adds son’s name to her bank account as a joint owner. The account reads “Mom and Son.” Either Mom or Son can write checks. No gift is completed because Mom has not actually given up control. She can sign a check and withdraw all of the funds from the account. Son can do the same. If and when Son writes a check on the account and withdraws the funds for himself, he has accepted the gift. The gift is complete.
Like the example of the home above, if a parent places a child’s name on a stock certificate with the parent, the gift is complete because it requires the child’s signature to sell the stock. On the other hand, establishing a brokerage account with a stockbroker in the name of parent and child which only requires the signature of one owner to sell or deal with the account is like a bank account and is not a completed gift when created.
If all of the above is confusing, do not be dismayed. The rules are simple. Once you have given up dominion and control over property or placed it in a structure which requires the signature of someone else in order for you to deal with the property, you have probably made a completed gift and gift taxes may be due.
Gift to Minors
You should never make a direct gift to a minor child. Gifts to minors should be in trust, under a Uniform Transfers to Minors Act Account or in an educational fund such as a Section 529 Account.
Gift taxes are imposed by both the federal and some state governments. The rules are similar but there are substantial differences. Tennessee, Mississippi and Arkansas do not have a gift tax.
Some gifts are exempt from gift tax. Because of the marital deduction, no gift taxes are imposed on gifts between spouses who are U.S. citizens. There is no limit. Spouses can transfer property back and forth to one another without any gift taxes. In the case of non-citizen spouses, there are limitations on how much can be transferred between spouses.
Each of us can make tax free gifts to non-spouses. The current exemption (2014) is $14,000 per year per donee without gift tax liability. Father can make a $14,000 gift to each of his children each year and incur no gift tax liability. There is no income tax liability imposed on the children or the parent by making a gift.
If gifts exceed $14,000 (2014) per donee per year, the excess is applied against your $5.250 million exemption (2014) for federal gift tax purposes. No federal gift taxes are due until this exemption is fully utilized. Once this exemption is fully utilized, you can assume federal gift taxes at approximately 40 cents on the dollar.
Some gifts under $14,000 per year are not exempt from gift tax. Generally these are gifts to trusts or gifts of what are referred to as “future interests.” An example of a gift of a future interest is a gift where the parent gifts the home to the children retaining a right to live in the home for life. Because the children do not receive the home until the parent dies, this is a gift of a future interest. Gift tax exemptions are not available. Taxes may be due.
Income Tax Issues of Gifts
Generally, there is no income tax consequence of a gift. A gift is not income to the donee. There is no income tax deduction to the donor. However, there are some income tax ramifications that you should not ignore.
The principal income tax ramification of a gift is that the donee retains the basis of the gifted property. Assume Dad buys stock in 1990 for $25 a share. This year Dad gifts the stock to his son. At the time of the gift the stock is worth $50 per share. Dad has made a gift of $50. Son’s income tax basis is $25 per share. Son’s income taxes when he sells the stock will be the same as Dad’s income taxes had Dad kept the stock and sold it himself, i.e, stock sold for $50, therefore Son will report a gain of $25 per share.
In addition, when a gift is made, the holding period is the same as the donor. If Dad (Donor) has a long-term holding period, the Son (Donee) will also have a long term holding period.
Because basis is adjusted at death, had Dad held the stock until death and then willed the stock to son, son’s basis in the stock would have been the fair market value on the date of Dad’s death. Then if son elected to sell the stock, he would have little or no taxable gain. When considering what assets to gift, it is best to gift high basis assets rather than low basis assets because inherited property receives a new basis.
In a small estate, gifting can produce significant tax issues and problems. Consider Dad who purchased a home in 1980 for $50,000. The home is now worth $250,000. Dad gifts the home to his son. He is entitled to a $14,000 exemption at the time of the gift. He applies the balance of the gift against his federal gift tax $5.250 million exemption and pays no federal gift tax. The home represents Dad’s principal asset. His other assets total $200,000. Dad lives in the home a few years, goes into a nursing home for a few months and then passes away. Son sells the home for $300,000. Son has a $250,000 capital gain ($300,000 sale price minus the $50,000 cost basis). Under current income tax law, he pays about $59,500 in income tax.
Had Dad retained the home and willed the home to son at death, son would have received a basis equal to the fair market value at death, or $300,000. Given that this is the major asset of Dad’s estate, there would be no estate tax. Son would have received a step up in basis in the home to $300,000. He could then sell the home and pay no income tax.
For gift tax purposes, a husband and wife may elect to split gifts made by either spouse. This allows one spouse to gift up to $28,000 to a single beneficiary in one year and still have no gift tax liability. Gifts are split between husband and wife through the filing of a gift tax return which elects gift splitting. Even though no taxes are due, the gift tax return must be filed to split the gift.
Gift Tax Returns
Gift tax returns to the federal government are required in the case of any gift in excess of $14,000 per donee per year or for any gift which otherwise produces a gift tax liability, even if offset by an exemption. When in doubt, you should always discuss with your tax preparer whether or not a gift tax return is due. Failure to file gift tax returns can produce substantial penalties and interest which could easily have been avoided.
Reducing Estate Taxes through Gifts
For significant estates that will likely generate federal estate tax gifting during lifetime may substantially reduce those taxes. As stated above, gifts to children of $14,000 per year per child can be made without gift tax liability. Although $14,000 does not sound like a lot of money, consider the parent who gifts $14,000 to a child each year over 15 years. Had the parent not made the gifts, then the value of the $14,000, invested at a 6% return is over $350,000. By gifting the $14,000 each year over 15 years, the parent has reduced his or her estate by over $350,000 and perhaps saved as much as $140,000 in death tax.
Gifts can be made to children, their spouses, grandchildren or anyone.
For those with larger estates, making a substantial gift and utilizing the $5.250 million federal gift tax exemption removes all growth on the gifted property from the donor’s estate. For instance, gifting $1 million, assuming the assets grow at 6% per year, will remove nearly $1.4 million from the donor’s taxable estate if the donor lives for 15 years following the date of the gift. A death tax savings of approximately $560,000 is possible.
Questions are often asked about the advisability of gifting away one’s assets in order to qualify for Medicaid benefits should one enter a nursing home. The Medicaid rules provide that any gifts made within five (5) years from the date of making application for Medicaid nursing home benefits are taken into consideration and will disqualify you for such benefits. Accordingly, if you desire to make gifts to protect assets should you enter a nursing home, you must begin the gifting process sooner rather than later.
Gifts are a Valuable Estate Planning Tool
Gifts serve to reduce some estates and eliminate distribution problems for others. They do not always result in the lowering of the total tax burden to the family. Before making gifts of any property to family members, one should always investigate whether or not there will be gift tax liabilities, the impact on future Medicaid benefits should you enter a nursing home and the income, estate and inheritance tax consequences of the gift as well.
Last but not least, non-tax considerations of making gifts often outweigh the tax considerations. You should make gifts for the right reasons but you should also know the tax consequences before completing the gift.
A. Stephen McDaniel, Cynthia J. Tobin and Robert D. Malin (2014)
Wyatt, Tarrant & Combs, LLP
1715 Aaron Brenner Drive, Suite 800
Memphis, Tennessee 38120