Providing for your loved ones during your lifetime
People make gifts for a number of tax and non-tax reasons; make sure gifts make sense for you in the context of your wealth management plan
What is a gift?
A gift occurs when one person—the donor—transfers something of value to any other person or entity—the donee or recipient—and receives nothing of value in return. This includes both clear gifts (e.g., giving money to a donee) and perhaps less obvious gifts (e.g., allowing someone to live rent-free in real estate that you own).
Gifts are different from sales, where the person selling receives from a buyer something of value in exchange for his or her asset, and from loans, where the person lending receives from a borrower a promise to pay the loaned amount plus interest over a period of time.
Why do people make gifts? Why are completed gifts important?
There are a number of reasons why people make gifts. Fundamentally, donors want to take financial care of their donees, whether those donees are individuals or charities, and often use gifts as one way to show their affection for their donees. However, many gifts are in part motivated by tax benefits. Note: though lifetime charitable gifts can provide an income tax deduction, the focus here is on the transfer tax (e.g., gift, estate, and generation skipping transfer (GST) tax) benefits of non-charitable gifting.
When people transfer assets, they may be required to pay gift tax (if they transfer assets during lifetime) or estate tax (if they transfer assets upon death), if the value of the transferred assets exceeds certain applicable tax exemptions, which are discussed below. When a person makes a gift during his or her life, all of the appreciation on the gift from the date of the gift onward accrues to the donee of the gift and avoids being included in the donor’s estate for estate tax purposes at death. Many donors try to reduce future estate tax liability by removing the appreciation of an asset from the donor’s estate by making a gift. However, a gift must be complete (that is, the donor must not retain any benefit from the gift, such as the right to receive income from it) in order for it and its appreciation to be removed from a donor’s estate, so it is important to work with counsel when structuring your gift.
Exemptions from transfer tax
As you contemplate whether gifting makes sense for you, it is important to understand your available exemptions or exclusions from transfer taxes:1
- Marital deduction: transfers between spouses who are US citizens can be done free of any transfer tax; this means that these transfers will not use up any of the donor’s gift tax exemption (described below)
- Charitable deduction: donations to a qualified charity can be made free of any transfer tax; in addition, there could be income tax benefits to making charitable gifts
- Medical and education expenses (the Med-Ed Exemption): payments made directly to the medical provider or educational institution on behalf of a donee for qualified expenses are exempt from transfer tax
- Annual gift tax exclusion: donors are able to make gifts capped at a specific dollar amount to any number of donees each year free of any gift tax, and these gifts can be made as one single gift or in multiple tranches throughout the year. The cap is $15,000 in 2020 (or $30,000 for married couples). As an example, a married donor (with the consent of his or her spouse) can gift $30,000 to each of 4 donees in 2020 as annual gift tax exclusion gifts, totaling $120,000 in gifts, without paying any gift tax or using any gift tax exemption
- Gift and Estate tax exemption: donors are able to exempt from gift or estate tax the value in the aggregate of transfers during lifetime or at death capped at a certain amount; this exemption amount is $11.58 million per donor in 2020. Lifetime transfers that exceed the annual gift tax exclusion each year use up portions of this exemption
- Whatever amount of the gift tax exemption that is not used up during lifetime will be available at death as an estate tax exemption; however, many people choose to gift during lifetime rather than to make gifts at death with the hope that their lifetime gifts will appreciate for the benefit of the donees
- People who wish to use their gift tax exemption often do so in trust when the gift amounts are large and if they expect that these gifts will last for multiple generations2
- Generation Skipping Transfer tax exemption: the GST tax applies to gifts to individuals who are more than one generation removed from the donor—often grandchildren and more remote descendants, or trusts for their benefit. Donors are able to exempt from GST tax the value in the aggregate of transfer during lifetime or at death capped at a certain amount; this exemption amount is $11.58 million per donor in 2020, similar to the gift and estate tax exemption. Note: a single gift could incur both gift tax and GST tax and therefore can use up both gift and GST tax exemption if the donees (or their trusts) are more than one generation away from the donor. Often gifts to which the GST tax exemption applies use up both exemptions and are made in trust since the gifts are intended to last for multiple generations.2
What do you need to do to make a gift?
Once you decide that you want to make a gift, you need to think about what you want to give. The easiest way to gift is to write a check, wire money, or transfer securities to a donee; so long as the amount gifted during the calendar year to that donee does not exceed the annual exclusion, the donor does not need to do anything else. No one owes any tax on the transfer and no one needs to report the gift. However, if the amount gifted throughout the year does exceed the annual exclusion amount, the donor will have to file a gift tax return to reflect the gift amount and the used portion of his or her lifetime gift tax and GST tax exemptions. (If a donor wishes to use a spouse’s annual exclusion amount, he or she will need to file a gift tax return to show consent; in addition, a donor can allocate or opt out of allocating his or her GST tax exemption to specific gifts on a gift tax return.) Be sure to speak with your tax advisor when making gifts so he or she can prepare a gift tax return if necessary.
Consider the following when finalizing your gifting strategy
- The best assets to gift are often those that you expect to appreciate in value—namely those whose value you believe is low relative to what it should be or will be in the future. (Note: in some instances, it may not make sense to gift assets that already have embedded gains, since you would effectively be gifting an embedded tax liability.) In addition, an asset whose fair market value warrants a valuation discount—because of its lack of marketability, lack of control, associated restrictions, etc.—may be an appropriate asset to gift since you would be able to transfer more value for less gift tax exemption when making the gift
- If you wish to gift assets that are hard to value, you will have to obtain an appraisal of the gifted asset and file the appraisal with a gift tax return to substantiate the gift’s value; gifts of cash and marketable securities generally do not require an appraisal unless a valuation discount (e.g., a block discount) is warranted. There is often a cost associated with obtaining an appraisal.
It is important to work with your tax advisor when making your gifts to ensure that these general concepts of gifting apply to your plan. Your J.P. Morgan representative is here to discuss and consider the alternatives with you.
1These exemptions reflect the Federal transfer tax regime applicable to U.S. citizens and permanent residents; consult with your tax advisor to understand your specific state’s transfer tax rules.
2There are a number of benefits to making gifts in trust. To understand if a trust might make sense for you, consult your JPMorgan representative.
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