Generosity doesn’t always come with a timetable, but if you have been thinking about when to make large gifts of cash or property to someone, now might be a good time.
These unique times we’re all currently living through may make now the best time in recent history to give a large gift. The economic impact of COVID-19 has depressed asset values, we have continued low interest rates, and legislators have temporarily increased gift, estate and generation-skipping transfer (GST) exemptions to historic highs; the federal tax exemption is $12.06 million per person, $24.12 million for couples in 2022 (the Connecticut gift tax exemption is $9.1 million). So this could be the perfect time to make a large gift to minimize your tax burden.
What Does the IRS Consider a Gift?
According to the IRS, a “gift” is any transfer of cash or property where the giver doesn’t get something of equal value in return. So, if you sold a $500,000 home for $300,000, that would be considered a gift by the IRS. If you loaned money to someone without charging interest or forgave the loan, this would also be a gift. However, when you pay tuition bills or medical expenses directly to the provider for another person—in any amount—this contribution is not considered a gift by the IRS and therefore is not subject to gift taxes.
What is a Gift Tax?
A gift tax is exactly what it sounds like: tax you must pay for the (large) gifts you give. Congress created gift taxes to deter individuals from giving away assets while they are alive as a way of avoiding estate taxes after their death.
Your annual gift tax exclusions allow you to make gifts to individuals up to a certain amount per year without paying a tax on the gift. The IRS currently allows annual gifts per person to be $16,000 a year to as many people as you want without incurring taxes for you or them.
If you plan to give an individual more than $16,000 in a year, however, it doesn’t necessarily mean you’ll have to pay a gift tax. There is a lifetime gift tax exemption, the unified tax credit, which is the total amount you (and your estate after you pass) can give away tax-free over your lifetime. The unified tax credit applies to gifts you give while alive and the value of your estate after you die. The Tax Cuts and Jobs Act of 2017 doubled this amount from $5.49 million to $10.98 million. The federal tax exemption is $12.06 million per person for 2022 since it’s indexed for inflation.
Any amount you choose to give an individual each year will chip away at your lifetime maximum. If you decided to give your son a gift of $15,000 in December 2021 and another of $16,000 in January 2022, you wouldn’t have to pay gift taxes on that amount since it matched the annual limit (and you’d be free to give an equal amount to any other individual).
The higher limits are set to expire automatically in 2025—and could be reduced sooner if Congress enacts new legislation. It will revert to the pre-2018 level of $5 million (adjusted for inflation) unless new legislation gets passed. Most experts don’t expect the exemptions to stay at this historic level.
That means, if your estate is worth more than $5 million, you might do well from a tax perspective to gift some of the difference between that and the current maximum ($12.06 million) to avoid estate taxes after your death.
What is an Estate Tax?
The estate tax is a tax on estates (everything that encompasses a person’s net worth including real estate, cash and other assets) whose value exceeds the exclusion limit set by law. There is a federal estate tax and many states also have their own state-level estate tax. So, in our example, a person’s estate would have to pay tax on any value beyond the exclusion amount, which may be substantially lower beginning in 2026. That’s why it could be advantageous to gift cash, assets, or property now and save on estate taxes in the future.
Act Fast: Gift Now to Take Advantage of Economic Reality and Tax Benefits
If you intend to gift property or assets (as opposed to cash) now is definitely an advantageous time to do so. Our depressed economy has temporarily suppressed the value of some assets, but the value of a gift for tax purposes is determined by the valuation of the gift when it was given. So, there will be less taxes to pay or lifetime exemption used on gifts you give now due to their lower valuations.
For example, if you have a piece of real estate that has decreased in value now, due to the current crisis, you could gift it at the current value, with the expectation that the value will go back up in the future. That future appreciation would accrue to the benefit of your beneficiaries and would be free of gift tax and estate tax.
Put another way, if you give now, and the assets appreciate, the appreciation won’t be subject to high gift and estate taxes. This makes giving now a wise move because you can gift more for less!
Nobody knows for sure what incoming lawmakers will enact for legislation. Still, the expectation is that changes to the estate and gift tax code are imminent and might happen before the current exemptions expire in 2025. These exemptions could fall at any time.
In addition, if part of your estate plan includes an intra-family loan, the applicable federal rate (AFR), which is the minimum interest rate that can be used for such loans, is at an all-time low. It could make sense to make the loan now, even if it won’t be used for a short period of time.
What If I Gift Now and the Exemption Drops?
The best news is that if you choose to make large gifts to take advantage of the favorable gift exemptions before they expire, you are “locked” in. If the exemption changes to a lower amount in the future, the reduced exemption amounts won’t be retroactive. Gifts made using today’s record-high exemptions are protected from future tax when the exemption amounts are reduced. The IRS has clearly said there will be no “claw-back.”
Of course, every personal financial circumstance is unique, so if you would like advice on your particular situation, please give us a call at 203-489-5362 or to set up an appointment to learn the best way you can use gifts now in your personal estate planning.