A Time of Giving – Tax Considerations

(Last Updated On: January 24, 2017)

We are at the time of year when our thoughts turn to giving—of thanks and more tangible items. The musings here will not reflect upon charitable giving–that is for a later entry.

Rather it will deal with the more mundane and practical aspects of gifts to individuals, typically (but not necessarily) family members.

We first note the personal gratification of gift-giving and the generous impulses that inspire it—but there are also tax considerations.

If income-producing assets, e.g., corporate stock with dividend potential, are the subjects of gifts, income can be “split” among family members thereby reducing the overall income tax burden on the family. Also, property that is the subject of a gift is removed from the donor’s estate for estate tax purposes.

What are the gift tax consequences of intra-family gifts? As a starting point, in 2008, there is a $12,000 per donee exclusion from the gift tax base. This means that an individual can make gifts totaling $48,000 to four children with no gift tax consequences whatsoever (and no need to file a return). Further, a spouse also has a $12,000 per donee exclusion. Thus, gifts totaling $96,000 could be made by a married couple, and this is the case even if only one spouse is the source of the gifts, so long as the couple files a gift tax return and the non-donor spouse agrees to “gift-splitting” for tax purposes. Note: if gifts are made in a non-direct manner, say, to a trust, there are criteria that must be met for the gift to be eligible for the annual exclusion, and the advice of a CPA or a tax attorney should be sought.

Note: On January 1, 2009, the annual exclusion rises to $13,000 per donee.

Care should be taken in the selection of donated assets. Again, gifts remove the donated assets from the donor’s estate, but that is not all—future appreciation in these assets is also removed. If stocks gifted during a downturn make a comeback, the estate tax reduction can be dramatic.

The choice of assets may also have a potential income tax impact, one which may suggest choices other than those suggested by gift and estate tax considerations. In general, a donor’s tax basis in assets carries over to the donee, shifting the potential capital gain from one to the other. However, under present law, were the donor to retain the asset until his or her death and leave it by will, the asset would receive a “stepped-up” basis equal to the stock’s value at the date of death. For assets that have appreciated markedly since their acquisition and particularly for assets given by donors whose estates have a value below the estate tax exemption (currently $2 million, due to rise to $3.5 million in 2009), it may be wiser for the donor to retain these assets.

Further, it may be better planning for the donor to sell and realize a loss on assets whose values have declined since they were acquired, as may often be the case in the present climate. This allows the potential donor to apply the loss against capital gains plus $3,000 of ordinary income on his or her own income tax return. Transferring depreciated assets may mean that the tax loss may never be realized by anyone, since, for purposes of determining loss on gifted stock, the donee’s basis is the lesser of: 1) the donor’s basis, or 2) the fair market value at the date of the gift.

Example. Donor owns stock of X Corp for which he paid $20,000. On December 1, when it is worth $10,000, he gifts the stock to his daughter, who later sells it when it is worth $12,000. Obviously, the daughter has no gain, but she also has no loss since the basis for determining loss is only $10,000. Had the donor sold the stock later himself, he would have realized an $8,000 loss and could have given the proceeds to his daughter.

A few other considerations:

Exemption from Taxes. For 2008, each individual has an exemption from estate taxes of $2 million. This will rise to $3.5 million on January 1, 2009. While the estate tax is scheduled to disappear in 2010 (and return with a vengeance in 2011 with a $1 million exemption), it is widely believed that Congress will revise the current legislation and implement something along the lines of a permanent $3.5 million exemption. Within the estate tax exemption, there is a $1 million overall exemption from the gift tax, giving the donor even more of an opportunity to remove assets and their appreciation from his or her estate (again, with a potential for doubling this up to $2 million with the participation or consent of a spouse).

Tuition and Medical Expenses. Potential donors should also keep in mind the fact that the payment of certain expenses on behalf of other persons (and not just relatives) simply do not enter into the gift tax base and thus do not erode either the annual exclusion or the $1 million exemption. The first of these is the payment of tuition by a donor to educational institutions. Note that this exclusion applies to tuition only and not other educational expenses such as room and board, travel, and book and computer purchases. The second excluded category is medical expenses paid directly to the provider of medical goods and services. This could include, say, the payment by a grandparent of orthodontia for a grandchild, a not inconsiderable expense that would still leave the annual exclusion intact.

Clearly, there are a number of tax factors that need to be considered in making gifts and there may be competing considerations among the income, gift and estate tax impact. However, with the input of a CPA or tax attorney, implementation of an optimal plan should not prove daunting to potential donors.