You may or may not already have your estate planned for when you die, but did you know that you can also make gifting your assets while you are alive a part of your estate plan? Most people are aware that you, as an individual, can gift up to $15,000 per year to any other individual without having to report that gift on your taxes. That means you can give $15,000 to each of your ten nieces and nephews without reporting, even if the total gift is $150,000, because the amount is based on person to person. In fact, if you are married, you and your spouse can gift $30,000 to an individual. So, if you and your spouse choose to gift $30,000 to each of your ten nieces and nephews, you can make those $300,000 in gifts without reporting to the IRS. But what happens if you want to gift more than the yearly limit?
Current Law: Tax Cuts and Jobs Act January 1, 2019 – December 31, 2025
The lifetime gift limit is currently tied to the estate tax exemption set by the Tax Cuts and Jobs Act (TCJA). This means that for 2021, if a person dies, their estate is allowed $11.7 million in exemption and anything over that will be taxed by the federal estate tax. If you are married, you and your spouse are entitled to $23.4 million in exemptions. That number is if you die in 2021 and is scheduled to sunset back to $5 million in 2026, indexed for inflation; however, you are allowed to gift that amount in your lifetime, and if when you do die, the estate tax exemption is much smaller, the IRS will not go back and create back taxes. With Joe Biden being the new President, we don’t know how quickly this tax law will change, we only know what the plan is under the current law. We do know that President Biden has discussed a much lower estate tax exemption amount and an even lower lifetime gift amount.
Despite the large amount of lifetime gift exemption, you are not allowed to gift $11.7 million and also have an $11.7 million estate without tax implications. Whatever gifts you make (other than those yearly limit gifts) reduces your estate tax exemption dollar for dollar. This might not seem like a winning situation because at first glance the outcomes are the same, and that is true for cash, but some gifts may also reduce your taxable estate. If you have assets that will appreciate between now and your death, real estate, securities, etc., you might want to consider gifting those now so that that their appreciation is not heavily taxed on your death.
Should I gift cash?
Cash gifts can certainly reduce your taxable estate dollar for dollar. However, if you dip into your lifetime gift limit then the gifting may not be as valuable. A better strategy for gifting cash might be spreading annual gifting out over several people. In addition, there is no limit on paying for other people’s medical bills or qualified tuition payments, so that might be a factor depending on your family circumstances. You might also be able to use your cash to make an intra-family loan, which will be discussed below, or pay off debts.
Should I gift my home?
Many people ask if they should gift their home to their kids now, usually more of an asset protection question, but let’s discuss anyway. Gifting your house is almost always a terrible idea. It can cause a huge capital gains tax bill, especially in California and even more particularly in California. For example, if you purchased your home in Lafayette for $25,000 and it is now worth $1 million and you gift it to your children, your children receive the gift with your purchase basis, which is $25,000. That means if they sell it, they will have to pay capital gains on all of it except $25,000. However, if you die and they inherit the property, their basis in the property will be the fair market value on the date of your death. They receive what is called a “step up” in basis. For example, if you purchased the house for $25,000 and when you die it is worth $1 million, and they sell it for $1 million, there are no capital gains because your children’s basis is the $1 million it was worth on the date of your death.
In addition, if the home is not going to be your child’s primary residence, meaning, you are going to keep living there, then the property taxes will be reassessed to fair market value, thanks to Proposition 19. There are also issues in gifting and those gifts being “clawed back” or still able to be used to pay creditors, or penalize you from qualifying for Medi-Cal.
What is an intra-family loan?
Another technique for gifting is called an intra-family loan. An intra-family loan Is a loan or promissory note between family members that must meet certain criteria set forth by the IRS so that it is not considered a gift. Those criteria include a minimum interest rate that must be charged, also known as the Applicable Federal Rate. Because the rates are so low right now, the lowest AFR in March 2021 is 0.11%, it could be very beneficial to make loans to family members who can then use that money invest in anything that has a higher return than 0.11%. While this transfer does not reduce your taxable estate (the money is still owed to the estate upon your death if the note is not paid), it can create an income stream for the recipient of the loan that is not a taxable gift. For example, if you loan your son $100,000 with a 0.11% interest rate for 30 years and he invests it so that he receives 5% annual interest on that $100,000, he will have earned $332,194 in interest and only owe $3,353 on the loan, making a net profit of $328,841. That is only simple interest, there are better investments out there for that $100,000 loan.
With the current administration just starting out, we do not know exactly where the estate tax and gift tax laws are going to go, but we can be sure that they are likely numbers that will be reduced greatly to help pay off some of our nation’s debt. Everyone should be revisiting their estate plans to maximize the current laws and take advantage of what potentially little time they have left.