You’ve often heard that when it comes to gift-giving, it’s the thought that counts. Unsurprisingly, the IRS doesn’t agree. To them, all that matters is that gifts are properly reported and taxed. Gift taxes are only required on gifts of significant financial value, so many people will never have to pay them. But if your estate planning strategy includes gift-giving, or if you anticipate making any generous gifts to loved ones in the coming years, it’s important to understand the potential tax implications. Both the annual gift tax exemption and the lifetime gifts exemption may affect your decisions around how to pass on your assets. Massachusetts estate tax law means Commonwealth residents need to be especially careful around lifetime gifts planning.
First things first: The IRS considers a gift to be any transfer in which the giver doesn’t receive full consideration. That is, if you give someone money or property without receiving something of equal value in return, it’s a gift.
As far as the IRS is concerned, you don’t need to report or pay taxes on any gifts that fall below the annual gift tax exemption amount. For 2020 and 2021, the gift tax exemption is $15,000 per gift recipient (donee). If gift taxes are owed, the person who gives the gift (the donor) is the one who pays.
Because the gift tax exemption amount applies to each donee, not the donor, it’s possible to make many substantial gifts to different people without triggering the annual gift tax. In 2021, you could potentially give $14,999 to every family member without owing any gift taxes. Spouses may also combine their gift tax exemptions. If you do make gifts in excess of the annual exemption amount, expect to pay taxes on the value of the gift that exceeds the exemption amount. The gift tax rate ranges from 18 to 40 percent.
While your annual gift tax exemption “resets” each year, each taxpayer also has a lifetime gifts allowance. For 2021, the federal lifetime gifts exemption is the same as the estate tax exemption: $11.7 million per person. Any gifts that an individual makes in excess of that exemption amount are taxed at 40 percent.
As you can imagine, a very small percentage of Americans will ever “use up” their lifetime gifts exemption while it’s set at nearly $12 million. However, estate and gift taxes are affected by changing legislation and we may see the exemption amount lowered significantly in the coming years. The current thresholds were set by the Trump administration’s Tax Cuts and Jobs Act. The Biden administration has previously proposed lowering the estate and gift tax exemptions to just $3.5 million and $1 million, respectively. (We’ll have plenty of advance notice if any new gift tax legislation is enacted, so I advise you not to worry about any potential changes just yet!)
That’s what you need to know about lifetime gifts on a federal level, but certain state laws may also be relevant if you made any substantial gifts. Here in Massachusetts, the estate tax threshold is just $1 million per person. When someone dies with an estate worth more than $1 million, the entire estate is subject to the estate tax.
The decedent’s adjusted taxable lifetime gifts are counted toward the value of their estate. Let’s say a Massachusetts resident gives a grandchild a gift of $200,000 to buy a house. She files a gift tax return and pays gift taxes on the $185,000 that exceeds her $15,000 annual gift tax exemption. Later, she dies with an estate valued at $900,000. The $185,000 taxable gift that she made must be added back into her estate to determine if it exceeds the $1 million threshold. The IRS would then consider her estate to be valued at $1,085,000 and the estate tax is triggered. Gift taxes were already paid on that $185,000, so the estate tax would only be owed on $900,000. That will still take a lot of money away from her beneficiaries since the Massachusetts estate tax is applied to the entire value of the estate above $40,000.
This is just an overview of how lifetime gifts and gift taxes can work, but there’s a lot more to know if there’s any chance that you’ll someday owe gift taxes. Keep in mind that any large transfer of money, including interest-free loans and contributions to a child’s 529 plan, can be considered gifts. I advise you to speak to your estate planning attorney about creating a tax-advantaged giving strategy before making any large transfers of money or property.
Ladimer Law is here to help with all your estate planning needs. Let’s make sure your estate plans support your giving goals so neither you nor your loved ones are hit with an unexpected tax bill later.
I welcome any questions you have about lifetime gifts or any other element of the estate planning process. Contact me today!
Julie Ladimer is the founder of Ladimer Law. She has been helping people complete their estate planning since 2014. She has been named a Rising Star by Super Lawyers three years running and received a Boston Magazine Five Star Professional award.
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Ladimer Law specializes in estate planning. We protect our clients, their heirs, and their assets by listening closely, knowing the law, and executing estate plans that fit and evolve.