When you give a gift to a family member or other loved one, there are certain tax rules that will determine whether to report that gift to the IRS (or state taxing authority).
Federal gift tax basics
Annual exclusion. Under the tax laws, you can provide cash gifts up to a certain amount to as many people as you choose without having to report those gifts to the IRS. The limit for each gift usually changes each year, but in 2021 it is $15,000. (Spouses can elect to give up to $30,000 to one person.) Any amount given in excess of the $15,000 will be considered a taxable gift to the donor and will need to be reported on an annual gift tax return. The amount is not considered to be taxable income to the recipient.
Qualified transfers exclusion. In addition to the gifts you can make as noted above, you can also provide an unlimited amount for qualified tuition or medical expenses to an individual. You must pay the amount directly to the educational or medical care provider.
Applicable exclusion amount. The amount that you can give during your lifetime and at your death (over and above the annual exclusion amount) is $11.7 million per person for 2021. This amount will be increased for inflation each year but is scheduled to revert back to 2017 levels (approx. $5 million) in 2026. The donor will be subject to estate tax on the amount of total taxable gifts less the lifetime exclusion given during their lifetime and at their death.
In your gift planning, give priority to annual exclusion and qualified transfer gifts, which can be made to anyone for any purpose. Remember, too, that if you don’t use the annual exclusion in a given year, you can’t make up for it later.
As part of your planning, remember that you and your spouse can split gifts that either of you makes to get the best use of each of your annual exclusions and applicable exclusion amounts. For example, if you have 2 children, you and your spouse could make annual exclusion gifts totaling $60,000 to your children (2 spouses x 2 children x $15,000). If you make gifts of $60,000 for 10 years, you will have transferred $600,000 to your children gift/estate tax free.
Next, consider gifts that are sheltered by the applicable exclusion amount. But remember that use of the applicable exclusion amount during life reduces the amount available for estate tax purposes at your death.
If you have property with a value that has dropped, in most circumstances, you should avoid giving property that would produce an income tax loss if sold (basis in excess of sales price). The recipient would have a carryover basis, which means they would not be able to claim the loss. Consider instead selling the property, claiming the loss and then making a gift of the sales proceeds.
If you give a gift that appreciates in value over time, that amount of appreciation is not included in your gross estate when calculating federal estate taxes. However, while property included in your estate generally receives a step-up in basis (its market value when you die), lifetime gifts do not. As a result, it may be wise to compare the tax advantage of a gift with carryover basis, and income tax on gain if the property is sold, against the income tax advantage of a stepped-up basis and estate tax if you retain the property until your death.
When interest rates are low, one smart choice may be a grantor retained annuity trust (GRAT). In a GRAT, you transfer property to a trust, but you have the right to receive annuity payments from the trust for a certain period. The amount of the annuity payments is set using an IRS interest rate. When that period ends, the remaining trust property passes to your beneficiaries, such as family members. If you survive the trust term, the trust property is not included in your gross estate for estate tax purposes. Any appreciation in the trust property that is greater than the IRS interest rate used to value the gift escapes gift and estate taxation. The lower the IRS interest rate, the more effective this technique generally is.
A low-interest loan to family members is another choice. The interest rate shouldn’t be below rates in the market, however. If it is, the IRS will determine how much interest should have been paid and consider it as a gift. When market rates are generally low, though, a low-interest rate may be valid.
*As of 3/29/2021.