The Tax Bite on Gifting

Periodically, clients want to make gifts to individuals for a variety of reasons including college funding, estate planning, or just plain goodwill. And generally there are a lot of misconceptions about how gifts are treated by the IRS. The relationship between taxes and gifts does exist and it is important that you have a general understanding of these relationships and how your gifts can affect or be affected by gift taxes, income taxes and estate taxes.

Gift Tax

Generally, under current tax laws, you are subject to U. S. gift tax whenever you gift property other that under one of the following exclusions.

Annual exclusions-The gift tax does not apply to the first $10,000 you give to any individual in any year. For married couples, the exclusion is $20,000. So a husband and wife with two children may give their children up to $40,000 each year ($20,000 per child). Starting in 1999, the $10,000 exclusion will be adjusted for inflation and rounded down to the next lowest multiple of $1,000. (If your gifts are made to a trust for the benefit of an individual, the trust must satisfy certain requirements in order to qualify your gifts for this exclusion from the gift tax.) You are not required to file a gift tax return if your gifts do not exceed these exempt amounts during the calendar year.

Marital exclusion-There are no limits on the amounts of property you can gift to your spouse without gift tax if your spouse is a U.S. citizen. If your spouse is not a U.S. citizen (even if living in the U.S.), special rules and limitations may apply.

Tuition and medical care-The gift tax does not apply to gifts or payments made for a person's "tuition" or "medical care" (including health insurance premiums). It is required, however, that the payment be made directly to the school, doctor, hospital or insurance company. The exception is not available if you reimburse someone else for these expenses.

Income Taxes

Although it is a common misconception, you are not entitled to an income tax deduction for gifts to individuals. However there are usually no income tax consequences as a result of gifts you receive. Your gift is not considered "income" to your donee but any income generated by the property, such as interest or dividends, after the transfer of the gift is treated as income taxable to the individual. Generally, the donee takes over your basis in the property and may recognize capital gains on the sale of the property.

Estate Tax

Many people will try to use gifting to reduce estate taxes by moving the assets to the intended beneficiary under the annual exclusion allowance. In regards to the property that is actually transferred, it is effective in removing the assets from the estate. But, depending on the value of the estate, gifting is generally not recognized as an efficient way to deal with a legitimate estate problem. It can, however, be effective in cases of smaller estates and as a tool to maintain a more extensive plan. But it's important to avoid naming yourself as custodian if gifting to a minor. If you die before the account terminates, the account will be included in your estate. This is true even though the transfers to the account are completed gifts. Also, if you hold assets as trustee of a revocable living trust, you should not make gifts directly from your trust. Instead, these gifts require two separate steps. First, you should change title to the property (including cash) from the trustee's name to your name. Then, you give the property to the donee. This two-step process could help minimize the risk that gifts made within three years of your death will be taxed in your estate.

As a financial professional, I see these issues come up from time to time, but because of the sophistication of many of the situations I have mentioned I always recommend that my clients consult their tax advisor and /or their attorney before we move forward.

Gadi Pollack

G. Pollack & Associates

The author is a registered representative of Jefferson Pilot Securities Corporation, member of NASD, SIPC. Branch office: Advisors Financial Group. He owns G. Pollack & associates located at 4400 Post Oak Parkway, Suite #1660, Houston, TX 77027. Phone Number (713) 659-1212.

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