How the gift tax works.
The gift tax is the responsibility of the person who gives the gift, and the amount of tax due is based on the value of the gift.
Currently, you can give up to $14,000 per person to an unlimited number of people in a single year without incurring a taxable gift ($28,000 for spouses “splitting” gifts). The recipient typically owes no taxes and doesn’t have to report the gift unless it comes from a foreign source. You can also make unlimited payments directly to medical providers or educational institutions on behalf of others for qualified expenses without incurring a taxable gift.
Generally, if you make a gift that exceeds $14,000 to any individual over the course of the year, other than your spouse, it should be reported on a Gift Tax Return (IRS Form 709 PDF). Spouses splitting gifts should each file IRS Form 709, even when no taxable gift is incurred.
Under current law, you can give away up to $5.45 million¹ during your lifetime, over and above the annual $14,000 exclusion and any payments made directly to educational institutions or medical providers on someone else's behalf, and still avoid gift tax. For taxable gifts, each donor has an aggregate lifetime exemption before any out-of-pocket gift tax is due.
It’s important to understand that the $5.45 million exemption applies to gift and estate taxes combined—whatever exemption you use for gifting will reduce the amount you can use for the estate tax. This is what the IRS refers to as a “unified credit.” However, surviving spouses may claim any unused exemption from the deceased spouse. Note: The executor of the predeceased spouse’s estate must have elected on a timely and complete Form 706 to allow the donor to use the predeceased spouse’s unused exclusion amount. § 25.2505–2
Lifetime gifting and estate planning.
|Rates for 2016||Top rate||Exemption|
|Estate Tax||40%||$5,450,000 per person¹|
|Gift Tax||40%||$5,450,000 per person¹|
1. Estate and gift tax exemptions and exclusions are adjusted annually for inflation over a certain threshold.
Tax and estate planning concepts.
Taking advantage of the annual $14,000 exclusion and making payments directly to medical providers or educational institutions on behalf of loved ones is a great strategy that helps preserve your lifetime exemption. Most advanced wealth-transfer strategies minimize gift taxes by taking advantage of the annual exclusion, the lifetime exemption, and valuation discounts available under the law (a valuation discount means the gift is worth less than its apparent value for gift tax purposes.)
Other strategies to consider include:
Setting up a marital trust.
By setting up a marital trust, assets in excess of the estate tax credit pass to the surviving spouse without any current estate taxation (for U.S. citizens only; different rules apply for a non-U.S. spouse). A marital trust allows a surviving spouse to take advantage of the deceased spouse’s estate tax exemption without having a bypass trust in place.
Taking care of your spouse and children from a prior marriage.
With a qualified terminable interest property (QTIP) trust—the most flexible marital trust—the executor decides how much of the estate qualifies for the unlimited marital deduction. The surviving spouse’s needs and expenses are still taken care of during his or her lifetime, but the eventual distribution of trust assets to the first spouse’s children is protected. This trust is especially attractive for people with children from a prior marriage, or if there’s concern over what might happen if a surviving spouse remarries.
Capitalizing on a valuable home while you’re still living there.
A qualified personal residence trust (QPRT) allows you to transfer a residence into a trust for gift purposes, while retaining the right to live there for a period of years. At the end of the term, the residence is transferred to the beneficiary of the QPRT.
Minimizing gift value.
With a grantor-retained annuity trust (GRAT), the grantor transfers assets to a trust for a specified term, during which time he or she receives an income stream, in the form of an annuity, from the trust. The annuity payments reduce the gift’s value for tax purposes. At the end of the term, remaining assets pass to the beneficiary. This can be an effective strategy in a low-interest-rate environment assuming the grantor outlives the term of the trust, since the probability is high that assets in the trust will outperform the discount rate.
Transferring wealth from non-liquid assets.
Life insurance is often used in estate planning to create liquidity in the case of closely held or hard-to-sell assets (such as a family business, family farm, or significant real estate holdings). It is also used as a wealth replacement vehicle to provide for family members, estate tax liabilities, or charitable bequests. Also, by creating an irrevocable life insurance trust (ILIT), the policy is owned by the trust and life insurance proceeds will be distributed free of income and estate taxes.
Estate planning is complex. Be sure to consult with a tax professional and/or an attorney to ensure you’re using the best tax strategy for your particular situation.
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Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. Schwab does not provide legal or tax advice.