Last week, Vitaly talked about the basics of gifting, including the types of gifts, how gifts are taxed, and some other important concepts. In short, making direct gifts during your lifetime can be an incredibly effective way to transfer your wealth to loved ones and reduce taxes.
In this post, he’d like to share some tax-efficient strategies for making direct gifts. These strategies can help you transfer more wealth to your loved ones and favorite charitable causes while keeping taxes low.
Why Make Lifetime Gifts?
One of the key benefits of making gifts during your lifetime is that it allows you to transfer wealth to loved ones efficiently. Direct gifts are usually inexpensive, often only requiring a small state fee to re-title property in the recipient's name. By choosing the right gifting strategy, you can remove an asset, ideally an appreciating one, from your estate and reduce gift tax liability. Additionally, you get to see your loved ones enjoying the gifts you give.
However, there are a few risks to keep in mind. Once a gift is made, it’s nearly impossible to undo. The recipient has legal ownership, and unless the gift was made under undue influence (which is difficult to prove), there's little you can do. There's also the risk that the recipient may not use the gift as intended. For example, a grandchild might misuse money meant for education on something else, or the donee may sell a house or family business ownership to an outsider against your wishes. To mitigate these risks, you can use irrevocable trusts, where a trustee manages the assets according to your intentions.
Nontaxable Gifts
Before making a gift, remember that some gifts do not incur gift tax. These include:
Annual Exclusion Gifts: In 2024, you can gift up to $18,000 per person without incurring gift tax. If you have three children and five grandchildren, you can gift a total of $144,000 per year tax-free – that’s a sizeable amount. If you’re married, you and your spouse can double this amount to $288,000.
Qualified Transfers: Direct payments to educational and medical providers on behalf of someone else are tax-free. For example, you can pay for someone's tuition or medical bills without triggering gift tax or generation-skipping transfer tax. There is no limit on the amount you can transfer this way.
Charitable Gifts: Gifts to 501(c)(3) organizations or government entities for public use are also nontaxable.
Unlimited Marital Deduction: You can transfer assets to your US spouse tax-free. However, be mindful that this can result in the surviving spouse having too many assets, potentially subjecting them to estate tax. Proper estate planning can help minimize this impact and he will talk about it in the future.
Whenever possible, consider making nontaxable gifts first. All other gifts will either incur gift tax or count against your lifetime gift exemption.
Strategies for Single Donee
If you are looking to make a gift to a single donee and your goal is to minimize your overall gross estate, avoid gifting cash. Instead, gift assets expected to appreciate the most. This removes the property from your estate and eliminates potential estate tax on future appreciation, as it occurs in the donee's hands, not yours. This strategy is effective if you have a significant life expectancy and wish to transfer assets like real estate, business interests, securities, art, patents, and royalties.
But avoid gifting property with unrealized losses, as the donee cannot use the loss. Instead, sell the property, recognize the capital loss, and use it to offset your taxable income - this is a way more efficient option.
Strategies for Multiple Donees
If you're gifting to multiple people, consider the following strategies:
Gift Appreciating Assets to Younger Recipients: This ensures that future appreciation occurs outside your estate, and younger recipients benefit longer from compounding growth.
Gift Income-Producing Property to Low-Tax-Bracket Donees: This strategy shifts income to a lower-taxed individual, reducing the family's overall tax liability and retaining more wealth within the family.
Gift Appreciated Property to Charities: Donating highly appreciated property allows you to avoid capital gains taxes. For example, if you own a stock and it has skyrocketed in value, donate the stock itself rather than selling it and donating the proceeds.
Gifts to Minors
Gifting to minors can be tricky, but here are some options:
Consider custodian accounts like the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) accounts. These accounts can be easily established and hold assets in the minor's name but are managed by a custodian, usually a parent, until the minor reaches adulthood, which is usually the age of 18 or 21 depending on the state. UGMA accounts can include cash, securities, life insurance, and annuities, while UTMA accounts can also include real estate and partnership interests.
The primary concern with UTMA/UTMA accounts is the lack of control over the assets once the beneficiary reaches the age of majority. If the beneficiary is financially immature, there is a significant risk that the assets could be misused.
A few other concerns to keep in mind is the negative impact on financial aid, the irrevocability of the contributions, and potential for the “Kiddie Tax” – a tax that is levied on unearned income above a certain threshold at a parents’ tax rate.
A better option of gifting to minors might be a 529 plan, which is a savings plan for education expenses. In 2024, you can contribute $18,000 per beneficiary without incurring gift tax. You can also "superfund" a 529 plan by contributing up to five years’ worth of gifts at once, which is 90,000 tax-free.
There are also sophisticated methods for gifting to minors using trusts, such as those under sections 2503(b) and 2503(c) of the Internal Revenue Code and life insurance trusts. He will cover those in a future video.
Summary
Implementing strategic gifting during your lifetime is a powerful tool for efficient wealth transfer and minimizing estate and gift taxes. By understanding and utilizing nontaxable gifts, selecting the right assets to gift, and employing advanced strategies for single and multiple donees as well as for minors, you can significantly reduce your taxable estate while ensuring your loved ones and charitable causes benefit from your generosity.
If you have any questions for us, please feel free to schedule a consultation below or request your free one-page financial plan.
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