The Surprising Benefits of Giving Gifts throughout the Year UPDATED for 2018 by Jeffrey M. Mutnik, CPA/PFS
Posted on December 28, 2017
Some of the best presents to receive are those that are not perfectly wrapped in a box or given on special occasions. Rather, there are often far more impactful gifts that individuals can give throughout the year to help their loved ones establish solid financial foundations. In some circumstances, these gifts can provide benefactors with not only the joy of giving but also significant estate-planning benefits.
Understanding Gift and Estate Taxes
The Internal Revenue Code provides U.S. taxpayers and resident aliens with multiple opportunities to transfer money or property to other individuals free of federal gift and estate taxes. For 2018, the maximum annual amount an individual may give to another person without incurring a gift tax is $15,000, or $30,000 for married couples. The tax laws allow individuals to make gifts up to these amount to as many people as they wish. Therefore, a married couple with two children and four grandchildren may in 2018 gift $30,000 to each of their six heirs, or a total of $180,000, free of transfer taxes. Any gifts that exceed these amounts will be subject to a flat 40 percent tax rate. However, gifting more than the annual exclusion amount to one person does not necessarily create a gift-tax liability. Individual taxpayers also have a lifetime exclusion, which effective on Jan. 1, 2018, allows them to transfer during life or at death up to $11.2 million in assets to their heirs without incurring federal estate taxes. For married couples, the lifetime exclusion is $22.4 million in 2018. While the Tax Cuts and Jobs Act of 2017 calls for these generous estate tax exemptions to expire on Dec. 31, 2025, there is no way to guarantee what Congress will do over the next eight years. It is also important to note that when couples split gifts between both spouses, each spouse will be consider to have given 50 percent of each of the other spouse’s gifts in that year. They will need to file a gift tax return, even if the gift is less than the annual exclusion threshold.
Making tax-free gifts throughout individuals’ lives may reduce the value of their estates and their exposure to the estate tax when they pass away. By gifting with warm hands, benefactors will also be able to witness the impact of their gifts and enjoy watching as loved ones benefit from them. However, there are specific rules that taxpayers must follow to qualify their gifts as tax-free transfers.
Gifts of Education
Due to the rising costs of tuition, coupled with the nation’s growing student-debt problem, a future college education is out of the financial reach of many individuals, including some with significant wealth and financial means. To mitigate this risk, families may consider establishing tax-advantaged 529 college-savings plans for young children and allowing the contributions they make today to grow tax-deferred until the children reach college age in the future. At that point, students can take tax-free withdrawals to pay for qualifying education expenses, including college tuition, books, computers and room and board.
The IRS considers contributions to 529 plans to be gifts of a present interest, which qualify for and are subject to taxpayers’ annual gift-tax exclusions. Because Congress understands that saving for higher education is good public policy, individuals are currently allowed to super-fund 529 plans with five years of annual exclusions. Therefore, a parent, grandparent or other individual can maximize his or her annual gift-tax exclusions of $15,000 in 2018 by making a $75,000 contribution to 529 college savings plans for each child and/or grandchild. Additionally, these contributions may qualify for additional state tax benefits. Imagine the savings that will accumulate over the next 18 years when an individual establishes and annually funds a 529 college savings plan for a newborn child today. Any funds that go unused after a child earns his or her degree may be transferred tax-free to other children, or they may go back to a benefactor who decides to return to school to further his or her education.
The state of Florida offers its residents a college-savings program that provides an additional opportunity to maximize future savings for a child’s college education. Under the Florida Prepaid College Program, families may lock in and pay for today’s costs for a child’s future education at a public university in the state. Should a child later select to pursue a degree out of the state or at a private university, he or she may apply the money saved in a prepaid plan to those institutions.
If saving for education is neither appropriate nor desired, individuals may instead pay a child’s tuition directly to a primary, secondary or college-level school. These payments made on behalf of another individual will not count toward a taxpayer’s annual or lifetime gift exclusion.
Gifts of Sound Saving Habits
Children are never too young to begin learning about the principle of saving today to build wealth for the future. In fact, parents may help children as young as five establish healthy savings habits and understand the benefits of compounding interest by putting money into Roth individual retirement accounts (IRAs).
While Roth IRA contributions are made with after-tax dollars, account owners have the benefit of tax-free withdrawals of those amounts at any time. However, it is important to note that account owners who withdraw earnings before they reach 59½ years of age and who have owned their Roth IRAs for more than five years may be subject to taxation and penalties unless they take distributions to pay for specific expenses. This includes payments for higher education and unreimbursed medical expenses that exceed 7.5 or 10 percent (based on age) of the account owners’ adjusted gross income.
Roth IRAs are ideal for children with summer jobs or who work during the school year and earn less than the modified adjusted income limit, which for 2017 was $132,000. Contributions grow year-over-year free of taxation. For example, consider a high-school teenager who earned $3,000 in 2017 through various odd jobs. The fact that he or she earned that income through work, and not from a portfolio or passive activity, allowed a retirement plan contribution of up to $3,000 by or on behalf of that worker. Usually, there is no current tax benefit for contributing to a traditional IRA, as there is no income tax on those earnings in this fact pattern. Therefore, family members may make contributions to a student’s Roth IRA and remove those assets and their future appreciation from the benefactors’ taxable estates.
Gifts of Charity
There are a multitude of non-profit organizations that rely on public donations to achieve their missions and goals, which can include supporting underprivileged families and disaster victims, increasing awareness or funding research for medical disorders/diseases or promoting global peace. It is well known that individuals may receive a tax deduction and reduce their taxable income when they reach into their pockets to support charitable organizations throughout the year. Monetary donations may be in the form of honorary gifts made on momentous occasions, as tributes to someone who has passed away, or simply to support a cause that is close to a donor’s heart.
The U.S. Tax Code also allows individuals to annually transfer up to $100,000 tax-free from an IRA directly to a qualified charity. These Qualified Charitable Distributions (QCDs) allow individuals over the age of 70½ to satisfy their annual required minimum distributions (RMDs) without adding the transferred amount to their taxable adjusted gross income for the year. However, because a QCD is not income, the donation may not be taken as a deduction.
Likewise, an individual may consider establishing and funding a charitable remainder trust during life to allow a non-profit entity to invest and potentially grow his or her donations. At the time of the donor’s death, any remaining trust principal will be gifted to the beneficiary charity.
Gifts to Spouses
Generally, there is no limit on the number or dollar value of gifts that spouses may give to each other without incurring federal gift-tax consequences. To qualify for a tax exemption, gifts between spouses may not include special demands or limitations on how or when the receiving spouse may use the gifts, nor may any gifts be considered “future interest,” which are subject to federal gift taxes. When one spouse is not a citizen of the U.S., however, the maximum amount that he or she may receive tax-free from a spouse who is a U.S. citizen is $152,000 in 2018. Anything above this threshold will be subject to transfer taxes.
Tax planning and gifting strategies should not be limited to the once-per-year tax filing deadlines. Rather, there are countless opportunities throughout the year when individuals may consider giving tax-free gifts to benefit someone else, whether it be for the birth of a child, a marriage, a birthday or simply just because.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors and Accountants, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.