Jimmy J. Williams, CPA/PFS, CFP®
Bringing Clarity to Gift Taxes
Many of us have worked extremely hard in life to accumulate a substantial amount of assets to fund our future retirement. The younger generation is buying homes, attending college, and beginning their lives in a way they had been accustomed from their parents. However, in the words of the great songwriter, Bob Dylan, “these times they are a changin’” accurately describes the economic environment for Millennials and Gen-Zs in 2022.
To ease some of the fiscal burden experienced by our children and grandchildren, gifts are often given to them. As you are aware, there are no free lunches in life – even if you paid tax on the funds when you earned them – and you wish to gift funds to your heirs. Each year the annual exclusion, an amount the IRS deems to be free from reporting as a taxable gift, is announced. In 2022, the amount a person may give another without reporting the gift is $16,000.
If your spouse and you wish to help your child’s family purchase a new home, while keeping the monthly mortgage payment at a level the child can service, many resort to gifting cash to the heir. Assume the child is purchasing a $250,000 starter home (yes, I know that is a lot of money for a starter house but re-read the Bob Dylan quote in the first paragraph of this article) and the required deposit is 20% of the purchase price. To accumulate the $50,000 down payment would require considerable time and savings for your heir.
To reduce the timeline for saving the funds, you simply wish to gift the funds to your child and her spouse. If the structure of the transaction is performed correctly, your children will be in a house before you can say “straight amortization.” One parent may give each of the children, your daughter, and her spouse, $16,000 each or $32,000 in total. We are still short of the down payment amount but let us keep designing our gifting plan. The other parent may gift the same amounts to the daughter and spouse and – voila – we now have $64,000 available for the down payment of the new residence.
Now, the question arises, how do you report these gifts on a return to the IRS? An IRS Form 709 is required to be filed by April 15 of the year after gifts have been transferred to a donee. However, you are only required to file this form if your total gifts per donee exceed the annual exclusion amount ($16,000) in the calendar year. In our previous example, you will note that the parents gave only $16,000 to each of the donees thereby preventing the need for filing a gift tax return.
What happens when you gift a total of more than $16,000 to a donee? How much tax is owed on this transaction? Good news, again! Should you give a donee more than $16,000 in a given calendar year, a gift tax return is filed but the excess amount over the $16,000 is offset by your lifetime exclusion of $12.06 million. My point is that you have a considerable amount of gifting to be performed before taxation occurs in most cases.
Another strategy we employ with our clients is the funding of a grandchild’s education. By making a gift to fund the entire education estimated costs, the grandparent may gift five years of annual gifts in one year and elect to be prorated over the five-year period. For example, Grandpa Bob wishes to send Timmy to the University of Oklahoma in 15 years. Bob may gift a total of $80,000 to a fund that will grow and provide for Timmy’s educational needs when he reaches the age for college. Bob will file a Form 709 and pay no gift tax under the previously stated strategy.
Another misconception of gifting is that the donee believes she owes income tax on the gift. By its definition and nature, a gift is something given to another without consideration being transferred to the donor. In simple language, you can receive a million-dollar gift and pay no income tax. Is this a great country or what?!?
To avoid estate and gift taxes, as well as the reduction of income taxes, it is vital that you plan accordingly prior to transferring your gift. Certain assets contain characteristics that may require special treatment under the Internal Revenue Code. It is critical that you consider the tax implications prior to effecting the transaction. A CPA and CERTIFIED FINANCIAL PLANNERTM professional can help guide you in the gifting process in conjunction with your overall estate planning desires. Taxes may be a part of life, but they do not have to be the primary part of your life.
See you on the jogging trail!
Registered Principal, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Jimmy J. Williams is an Investment Advisor Representative of Compass Capital Management, LLC, a Registered Investment Advisor. Cambridge and Compass Capital Management, LLC are not affiliated. 321 S. 3rd, Ste. 4, McAlester, OK 74501.