An estate plan is a process by which you determine who will inherit your assets after your death in the most efficient and tax-effective way possible. As part of an estate plan gifting of assets sometimes occurs in order to reduce estate taxes at death, or for asset protection planning reasons for individuals who may be afraid that their assets will be exhausted for their long-term care.
A gift is a transfer of an asset to an individual when full consideration is not received in return. Clients sometimes believe that if they transfer their residence to their child for $1.00 instead of for free, then that transfer is not a gift. However, that is a gift equal to the fair market value of the residence over the amount received in return. For example, if the house is worth $100,000 and the child pays $1.00 for it, then this is a gift of $99,999 to the child.
Some transfers can be excluded from gifts and those include gifts to your spouse, gifts to pay tuition or medical expenses for someone else, or gifts that are not more than the annual exclusion for that particular calendar year. The annual exclusion is a technical term defining how much you are allowed to gift to any individual which you would like each calendar year. The annual exclusion amount used to be $10,000 per person per year. However, that amount was increased to $11,000 for the years 2002 to 2005, $12,000 for the years 2006 through 2008, and $13,000 beginning January 1, 2009. It remains $13,000 today. Therefore, you are allowed to make a gift to anyone for up to $13,000 in any calendar year. If you are married, you and your spouse each have the ability to make a $13,000 gift to a single individual in each calendar year. For example, if a husband and wife have two unmarried children, the husband can gift $13,000 to each of their children and the wife can gift $13,000 to each of the children as well, for a total amount of $52,000 in one calendar year.
One of the most misunderstood estate planning concepts, though, is what happens if you gift more than the annual exclusion amount to an individual in one calendar year. For example, let’s assume that an unmarried individual will be transferring their house valued at $100,000 to their only child. The first $13,000 of this gift is excluded because of the annual exclusion. However, what are the tax effects on the remaining $87,000? If you make a gift in excess of the annual exclusion to an individual in a calendar year, you will need to file a gift tax return, and no tax may be due. The $87,000 in excess of the annual exclusion amount will not create gift tax because in addition to the $13,000 annual exclusion amount, in 2012, you also have a $5,000,000 lifetime gift tax exemption. This lifetime gift tax exemption is also tied to your federal estate tax exemption, as well. This is how it works. In our example, the excess $87,000 of gift in excess of the annual exclusion would simply reduce the amount of your lifetime gift tax exemption from $5,000,000 to $4,913,000. That means that if the estate tax laws remain as they currently are and you pass away with assets less than $4,913,000 in your name, there will not be any estate tax to pay.
In this situation, neither the donor nor the donee has any responsibility to pay any gift taxes or income taxes. However, please remember that if the gift is in excess of the annual exclusion amount, you are required to file a gift tax return which is due at the same time that your federal income tax return is filed.
When planning your estate, please be aware that in most circumstances, there will probably not be any tax consequences of making a gift even if the gift is in excess of the annual exclusion amount (currently $13,000). This is because you still have the ability to use your gift tax exemption which is currently $5,000,000. For more detailed planning and to determine the specifics regarding your own particular planning matters, please consult your estate planning attorney.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.
James F. Contini II, Esq.
Certified Specialist in Estate Planning, Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway New Philadelphia, Ohio 44663