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In the spirit of #GivingTuesday, we want to discuss some of the important considerations and options as it pertains to gifting.
The annual gift tax exclusion amount is the amount a person can gift to several recipients without a gift tax consequence. This amount is $15,000 ($30,000 for gifts from spouses, i.e., split gifts) for 2021. The annual exclusion amount is slated to increase to $16,000 ($32,000 for split gifts) in 2022.
When determining how much annual exclusion you have available to give to a specific person, count the beneficiary’s share of insurance premiums contributed by you to any Insurance/Irrevocable Trust or by other gift but count no gifts for education tuition or medical expenses you paid directly to a school or medical provider, such as birthday or holiday gifts.
The annual exclusion does not carry over to future years. Therefore, you either use it this year, or you lose your chance to make a tax-free gift for this year.
Each person has a lifetime gift tax exclusion of $11,700,000, besides the annual exclusion gifts (explained above) and direct payments of medical or tuition expenses. Thus, an individual can make gifts over the annual gift tax exclusion amounts (discussed above) of up to $11,700,000 during their lifetime before having to pay any gift tax (though a gift tax return must be filed).
Before you use your lifetime gift tax exclusion, consult with a tax advisor to make sure that you use your lifetime gift tax exclusion in the most tax advantageous way.
Gifts between spouses are not subject to gift tax if the receiving spouse is a U.S. citizen.
Gifts to a non-citizen spouse are not eligible for a marital deduction or the gift tax exemption but are eligible for a special annual exclusion amount. This non-citizen spouse annual gift exclusion is $159,000 for 2021 (or $164,000 in 2022). There is no lifetime gift tax credit available to offset tax where such gifts result in a tax liability.
Any gift to anyone, including your spouse, can be made outright to a 529 Plan, to UTMA accounts, or to irrevocable trusts.
Payments for tuition and medical expenses are not considered taxable gifts and are not included in annual exclusion limits or in the lifetime exclusion. A donor, for example, can pay the tuition expenses for a loved one at any educational level with no gift tax consequence. To be exempt from the gift tax, payments must be made directly to the educational institution or medical professional. If you have a grandchild or child going to a specific college or educational institution, please inquire with your tax advisor how you can “prepay” for the tuition without it being considered a gift.
Section 529 of the Internal Revenue Code affords a taxpayer with an opportunity to establish a special account to pay higher education expenses. Investments in a 529 Plan accumulate income tax-free, and distributions used for qualified education expenses are not subject to federal income tax. One common technique is “frontloading” gifts to a 529 education savings plan. You can make five years’ worth of annual exclusion gifts, or $75,000, to a 529 plan in 2021 to benefit any one person, but annual exclusion gifting to that person over the next four years will be reduced by $15,000 per year. This is especially effective when markets are depressed.
A Grantor Retained Annuity Trust (” GRAT”) is an irrevocable trust into which you transfer assets into the trust and retain the right to receive annual payments of a fixed dollar amount for a specified term of years. At the end of the trust term, the remaining trust assets pass to family members or a trust for their benefit.
The IRS assumes that a GRAT will grow at a rate equal to the 7520 rates when the trust is established (1.6% for December 2021). Growth that exceeds the assumed rate passes to trust beneficiaries free of gift and estate tax. The lower the hurdle or interest rate, the larger the potential gift. GRATs are a preferred wealth transfer option in a low-interest-rate environment because it is relatively easier to outperform the hurdle rate than in a high-interest rate environment. Like many estate planning techniques, GRATs can be very effective when assets values and markets are depressed.
GRATs are also “grantor trusts” so the grantor (creator of the trust) is taxed on the income. Payment of these income taxes is effectively a tax-free gift to the trust beneficiaries since the trust assets can grow without a reduction in income tax payments.
Using a GRAT, a client can transfer assets to a trust on a gift-tax-free basis, receive the assets back over a period of years with a rate of return, and any excess growth is outside the client’s estate.
Many clients consider transferring their vacation properties or personal homes to their descendants. Individuals can make such a gift using a Qualified Personal Residence Trust (” QPRT”).
If structured properly, the QPRT will freeze the value of the taxpayer’s residence when they create the trust and transfer the residence, resulting in significant estate tax savings. After the gift, the donor can continue to live in the residence for the term of the trust, and potentially longer by renting the residence.
Note: QPRTs are considered most effective when interest rates are high.
Federal legislation permits individuals 70 ½ and over to again make a tax-neutral distribution of up to $100,000 from their Individual Retirement Account (IRA) to go directly from the IRA to a public charity. The charitable transfer may be earmarked for specific use within a charity, but it may not be designated for a donor-advised philanthropic fund, supporting foundation, charitable remainder trust, or charitable gift annuity. A transfer from an IRA, under this law, is excluded from federal income tax and qualifies toward the required minimum distribution but does not qualify for a charitable deduction.
The COVID Relief Act (the “Act”) passed by Congress and signed by the President on December 27 extended the unlimited charitable contribution for cash gifts to most public charities through the end of 2021. This creates an important once-in-a-lifetime opportunity to move substantial amounts from retirement plans to charity beyond the $100,000 qualified charitable rollover already allowed to IRA owners without adverse income tax consequences.
For some who wish to maintain some control while benefitting others, a Charitable Remainder Trust (CRT) could be an attractive option. A CRT is generally funded with appreciated stock or real estate and provides the grantor with a right to an income stream from the trust for a period of years or for the grantor’s life. Upon the trust’s termination, the assets in the trust are paid to the designated charity. Another charitable planning strategy is a Charitable Lead Trust (CLT). The CLT annually pays a charity during the term of the trust, with the trust principal passing on to the grantor’s children upon termination.
For those who wish to make substantial gifts to charity while retaining control over how the funds are distributed and used, a private foundation or donor-advised fund can be an option. Private foundations enable individuals to teach and/or have family members, even younger ones, become educated and involved with philanthropic activities. Typically, private foundations make gifts to other 501(c)(3) organizations. Sometimes, private foundations may make grants to individuals for charitable purposes. When making gifts to individuals, procedures must be followed, and a private foundation must gift to a broad class of individuals and not specific or pre-determined individuals.
Private foundations can make gifts to foreign charities. While an individual cannot take an income tax deduction for contributions to a foreign charitable organization, an individual can take a deduction for contributions to a qualifying private foundation. A private foundation can make grants to a foreign charity. The IRS rarely deems foreign charities to be public charities for U.S. taxes, but there are two ways that a private foundation can nevertheless seek to distribute to a foreign charity:
One option is for the foundation to obtain an affidavit from the charity itself or an opinion of counsel that the foreign organization would qualify as a public charity under the U.S. tax code. Recently proposed regulations would allow CPAs and enrolled agents to render such opinions. These “equivalency determinations” are tedious and expensive to complete.
Another option, which requires greater oversight but may be more cost-effective, is for the private foundation to forgo the equivalency determination and instead engage in something called “expenditure responsibility.” Expenditure responsibility requires that a private foundation establish procedures to see that a grant is used for the purpose made, to retrieve reports from the foreign charity on how the grant is used, and to report to the IRS. The foreign charity must also agree to hold the grant in a distinct fund dedicated to one or more qualifying objectives, including religious, charitable, scientific, literary, or educational purposes.
As you can see, there are many paths and tools available for gifting to both loved ones and charitable organizations. And laws are always changing. Schedule a meeting with us today to discuss which options make the most sense for you, depending on your goals and tax law considerations.