I recently received this article from a good friend outlining gift tax and estate planning from Charles Schawb. I found it to have good information that could also answer some questions when it comes to gifting down payments from relatives and what they and you need to know. As always its best to consult your personal CPA when making or receiving a gift for a down payment for your home. Feel free to call or message me below to discuss some down payment options for home loans.
Say your sister or one of your adult children needs money and you’d like to help out with a cash gift. Do you need to worry about the gift tax?
Most of the time, probably not. You can give away more than $5 million without racking up a penny in gift or estate tax. And if you’re married, the joint exclusion is upwards of $10 million. But you do need to understand the ins and outs of this levy and how it can affect your estate plan.
The most important thing to remember: Although the IRS doesn’t care when you make a major gift, the timing can make a big difference to your heirs. You get the same pool of tax-exempt money to play with whether you give now or through your will. Just make sure you understand all of the rules.
Gift and Estate Tax Limits and Exemptions
Giving large and reducing estate taxes
In 2014, the actual amount of your exclusion from federal gift or estate taxes is $5.34 million, a figure that will rise in future years to keep pace with inflation. You may use part or all of that during your lifetime to avoid gift taxes. Then, whatever’s left over can be applied against what you leave behind, to reduce or eliminate estate taxes your family might otherwise owe.
Every individual is entitled to these tax breaks, so if you give with your spouse, the exempt amount is doubled. What’s more, U.S. citizens get an unlimited tax exemption for the property they get from their spouses.
But there’s a further complication here—which can also be an advantage. Separate from the lifetime exclusion is an annual $14,000 tax break for gifts to individuals (this amount is also indexed to inflation). You and your spouse can give that much each year individually to as many people as you like without 1) using up any of your personal $5.34 million exclusion; 2) owing gift tax; or 3) even needing to file a gift tax return.
Although the IRS doesn’t care when you make a major gift, the timing can make a big difference to your heirs.
Let’s consider the following: Suppose you give two grandchildren $20,000 each in 2014 and give a family friend $10,000. You can forget about that last gift, because it’s less than the $14,000 annual exclusion. But the others? Portions of those gifts are potentially taxable, as they exceed the exempt amount by $6,000 apiece.
Still, unless you have already used up all of your $5.34 million lifetime exclusion, you won’t owe anything to the IRS. You’ll just be $12,000 closer to the point at which your gifts would be taxed. You’ll also have to file a gift tax return—IRS Form 709—to let the government know you’ve spent some of your lifetime exemption. That will also help you keep a record of your giving.
If you’re married, you and your spouse may give up to $28,000 to as many individuals as you like each year. For example, a married couple could give $28,000 to an adult child and $28,000 to each of their three grandchildren, for a total of $112,000. Although you’re combining the $14,000 exclusions you’re each entitled to, this is called gift-splitting. Splitting gifts may require you to file a gift tax return.
And if you do someday exhaust your lifetime allowance for tax-free giving? Then you or your estate would owe up to 40% in gift or estate taxes on the excess amount.
Special rules for gift tax exemptions
Want to make a gift without touching either the lifetime or annual exemptions? The IRS also gives you a free pass if you pay for someone’s medical or tuition expenses, just as long as the money goes directly to the institutions rather than to the patient or student you’re helping. As far as taxes go, it’s as if those weren’t gifts at all.
Then, in yet one more quirk of the tax laws, although contributing to a 529 college savings plan for a child or grandchild does count as a gift, you’re allowed to bundle five years’ worth of $14,000 gift tax exemptions into an initial $70,000 contribution.
But bear in mind that any additional gifts to that student during the next five years will put you over the annual giving limit and tap your lifetime exclusion. And if your lifetime should end before the five years are up? A prorated amount will get tossed back into your estate, but only for tax purposes. The money you gave stays in the 529.
In a final twist, if you give money to a charity now or in your will, the contribution is exempt from federal gift or estate tax and will probably earn you an income tax deduction as well.
Your giving plan, going forward
The bottom line is that giving sooner might make more sense rather than waiting to bequeath your assets after you die.
The first step is to decide (and also discuss with your spouse and attorney) how you want your estate to be divided. That can help you calculate which road—giving now or giving later—you should take in terms of your loved ones’ needs and your overall tax picture.
As you can see, there are a few ways to give to people that skirt both gift and estate tax issues. But even if you gave enough to incur the gift tax, remember that the recipient(s) would get your largesse tax-free—whereas if you waited until after you died, the gift would pass through the hands of the IRS first and your heirs would get what was left.
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