Wednesday, March 17, 2010

What Is the Annual Gift Tax Exclusion?

What Is the Annual Gift Tax Exclusion?

Gifting money can be a very effective way to transfer substantial amounts from your estate, free from gift and estate taxes, to your children or other loved ones. This technique of estate tax planning can drastically reduce your taxable estate after your death, and could thereby reduce your associated estate taxes.

The Federal Government levies taxes on what they call “gratuitous transfers of assets.” These are financial gifts in the form of money, stocks, bonds, property, or anything else you wish to give. The gift tax can eat away your at your estate. In 2007 through 2009, you can make a lifetime gift up to $1 million without gift tax. After that, 45 percent of each dollar gifted goes in tax. In 2010, the rate is the same as the top income tax rate. After 2010, the tax effectively starts at 37 percent and goes up in increments to 55 percent.

Luckily, there are certain exceptions to the gift tax as outlined in Section 2503(b) of the IRS tax code. One such exception is the annual gift tax exclusion. This is an amount that can be given away annually without resulting in gift tax on the transfer. This gift exclusion renews every year and is in addition to the $1 million lifetime exclusion. As easy as this may sound, there are certain criteria you have to meet in order for your gift to qualify as an exclusion, and there are even exceptions to the exception!

Let’s take a look at the Annual Gift Tax Exclusion as well as some exceptions to the rule.

Give a Gift of $12,000

In the year 2007, the Annual Gift Tax Exclusion amount is $12,000 per recipient. There is no limit on the number of recipients to which qualifying gifts can be made. The key word here is qualifying. That’s right! Not every gift will qualify for the Annual Gift Tax Exclusion.

The IRS does not consider a gift to be qualified unless the person receiving the gift possesses a “present interest,” an immediate ownership, in the asset. This means that, in general, transfers in Trust are not considered present interests, but future interests.

The unlimited marital deduction is an entirely different kind of gifting that allows spouses to give their property to their spouse without incurring any gift taxes. This is not true, however, if the spouse is a not a U.S. citizen. In this case, the Annual Gift Tax Exclusion kicks in, but has a much higher value of $125,000.

Gift-Splitting By Married Taxpayers

If the donor of the gift is married, gifts made during a year can be treated as a "split" between the husband and wife, even if the cash or gift property is actually given by only one of them. By gift-splitting, therefore, up to $24,000 a year can be transferred to each recipient by a married couple because their two annual exclusions are available.

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return(s) the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Since more than $12,000 is being transferred by a spouse, a gift tax return will have to be filed, even if the $24,000 exclusion covers the gifts. So, be aware that if you elect gift-splitting, you'll need to file IRS Form 709 gift tax return.

Giving to Minors

Oftentimes, when you choose to gift to a minor, you want to delay access to the gift but still receive the annual gift tax exclusion. Although typically, you have to give a present interest, there are approved vehicles for providing future interest. One such vehicle is the “Section 2503(c) Trust for Minors.”

In order for a gift to qualify under this Trust:

1. The money and interest in the Trust can be spent on the minor by the Trustee before the minor reaches the age of 21.

2. Any assets not spent by the time the minor turns 21 must be turned over to the minor.

3. If the minor dies before the age of 21, the assets in Trust must become part of the minor’s estate.

Another gifting strategy for minors is to establish a custodial account under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA). Using this strategy, assets are placed in a custodian’s name for the benefit of a minor. This custodianship ends when the child reaches adulthood, at which time the custodian must give all the property to the child. Once again, if the minor dies before reaching adulthood, the assets will be placed in the child’s estate.

Another method is using a standard Irrevocable Trust, like a Life Insurance Trust, and give the beneficiary the right to withdraw the money for a period of 30 days. This “Crummey” power, named after the case approving its use, converts the future interest into a present interest.

Even with these different gifting strategies for minors, you are still only able to gift $12,000 per year per recipient. You can arrange for larger gifts by providing monies used for tuition, health care, and charities.

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