Direct Gifts

Learn how to maximize your tax benefits for wealth transfer by making the most of direct gifting.

What are direct gifts?

Probably the most obvious form of wealth transfer, direct gifts are just what their name implies—monetary gifts given directly to your descendants. However, even with a straightforward transfer, there are rules and strategies to consider. Familiarize yourself with the taxes imposed on these gifts and discover the ways to best maximize your wealth transfer through direct gifting.

Taxes and direct gifts

Depending on their amount, direct gifts can be given tax-free. You may give up to a combined $5.34 million in life or death without the money being subject to estate or gift taxes; there is also a $14,000 annual exemption rate per donee. Couples can combine their annual exclusions to double this amount, meaning they can give $28,000 per donee per year. Even if only one spouse technically makes the gift, as long as both spouses consent, it is considered by the IRS to have come from both. This allows couples to maximize their gifting ability. In addition, all gifts you give to your spouse throughout your lifetime are tax-free, as long as he or she is a U.S. citizen. Annual gifts can make a big difference over time, and since they are a “use it or lose it” exclusion, it makes sense to transfer as much money as possible this way.

Since annual gift tax exemptions are based on the calendar year, timing is important when gifting. For example, instead of gifting $25,000 to someone in December, if you gifted $14,000 in December and the remaining $11,000 in January, you could avoid gift taxes altogether. If your gifting amount for the year does end up exceeding the exemption amount, you have to file an informational gift tax return for that year and your gifts will be taxed 40 percent of that amount. One thing to consider with estate and gift taxes is that if you have to choose between the two, it will usually cost less to gift (even if it is above the exemption amount) and pay the tax while you are living than to wait until after you die and pay the estate tax, because the amount you pay in gift tax will no longer stay in your taxable estate.

In addition to gift taxes, generation-skipping transfer tax (GST tax) is also a consideration for those subject to estate taxes. GST tax is applied to property that is passed to related persons more than one generation younger than the donor or to unrelated persons who are more than 37.5 years younger than the donor via a will or trust. This tax was created because many people had discovered that they could pass their estates directly to their grandchildren and therefore avoid one generation of estate taxes. GST tax rates and exemptions are the same as estate taxes, with up to a $5.34 million exemption and a 40 percent taxation rate.

Med-ed exemption

When giving money to descendants for educational or medical purposes, you can avoid taxes by giving an unlimited amount directly to their educational organization or health care provider. This exemption, known informally as “med-ed,” allows you to make tax-free payments to tuition bills or health insurance premiums and better the lives of your descendants without burning through your annual exemption.

Appreciated assets

Gifts do not always have to be in cash. By gifting appreciated assets, you not only move money out of your estate, but you also move any future appreciation of those assets out of your estate and out of the grip of estate taxes. Even when gifting investments or real estate, there are ways to keep your gifts under the annual exclusion rate. For example, you could gift some stocks right away and some stocks in the remaining years, or gift up to $14,000 of interest in a property each year. When gifting property, it can be wise to get appraisals and document these gifts in case the IRS tries to challenge the values during a tax audit.

Another benefit of gifting appreciated assets is a possible capital gains tax advantage. Capital gains tax is enforced on the amount that the value of the asset increases from its original value. For example, if a stock was bought for $2,000 and then gifted when it was worth $2,500, capital gains tax would be assessed on $500. If the recipient of your assets is in a lower tax bracket than yourself, he or she will end up owing less money on this asset.

You can also directly gift your appreciated assets to charity. When donating appreciated securities, both you and the charity are exempt from capital gains tax. One thing to consider when donating appreciated assets is that the income tax exemptions are lower than when donating cash—usually up to 30 percent instead of up to 50 percent.

Depreciated assets

When gifting depreciated assets, there are certain rules to keep in mind:

1. To determine capital gains, the donee must still use the original value of the asset rather than the gifted value. That means that if a donor bought a stock for $1,000 but then gave it to a family member when it was worth $800, to determine capital gains the donee would still need to consider the stock as worth $1,000.

2. If the asset is sold by the donee for less than the gifted value, the capital loss is calculated using the gifted value (in the previous example $800) rather than the original value.

3. If the stock is sold by the donee for an amount between the gifted value and the original value, the stock is considered as having neither a gain nor a loss. For example, if the donee sold the previously mentioned stock for $900, they would be considered as “breaking even,” because although they made $100 on the stock, the stock was still sold for $100 less than its original value. In this case, the donee loses out on any tax benefits from depreciated assets because they are not able to claim a capital loss, although the stock was sold for less than its original value.

It’s important to keep in mind that because of the complexity of determining a depreciated asset’s true value, it may make more sense (depending on your situation) to sell the assets, take the loss on your tax return, and then gift the proceeds of the sale to the recipient. Of course, this depends on your situation and the non-monetary value of the asset. If you’re gifting a depreciated asset that has a large sentimental value, such as a property used as a common family gathering place over the years, the non-monetary benefits may outweigh the monetary ones.

Gifting to minors

When considering giving to children under 18, there are a few things to keep in mind. Many families think it’s easiest to simply fund a bank account that your child will take charge of once they reach adulthood. This is called a custodial account, also known as UTMA (uniform transfers to minors act) accounts or UGMA (uniform gifts to minors act) accounts. As such, the account is technically owned by the child and the adult custodian has no legal ownership over the assets. However, the adult custodian is responsible for the management of these funds and can be liable for the loss of funds. This means that a child could sue his or her parents for “breach of fiduciary duty” if they make a bad investment with the money, even if the parents initially gifted the money.

In addition, many children aren’t ready to handle large amounts of money on their 18th birthday and end up losing large amounts of it due to irresponsible spending or investing. This isn’t a very attractive option for many parents, so when gifting to minors, trusts are a viable other option. Trusts involve less risk because the child is acting as a beneficiary and not an owner.

Is gifting right for you?

It may seem like a waste not to use the tax exemption of direct gifting, but you also must consider the cost of this choice if it doesn’t fit with your wealth transfer plan. It’s important to consider how you feel about parting with your assets and if you feel you will still have the money you need after you do so. You should also consider if your children or grandchildren are emotionally prepared to inherit a large amount of wealth. If not, it may be more fruitful to wait to gift money rather than gifting the maximum tax exemption amount each year and then watching your descendants squander it on an extravagant lifestyle.

However, gifting can also bring great emotional joy if you are able to help a child or grandchild pay for college or help your daughter pay for her wedding. If you wait to pass on money until your death, you won’t be around to see these emotionally satisfying results. In addition, since people now have a longer life expectancy, if you wait until death to transfer your wealth, your recipients may be nearing old age as well and may not find the financial help as useful. By considering the aspects of direct gifting that are specific to your family, you can help establish when and how to gift.