The ABC’s of making gifts: what clients need to know
Background
The Great Wealth Transfer is upon us, with the oldest of the baby boomer generation recently turning age 70. With it has come an unprecedented transfer of wealth. This, combined with the pending sunset of the Tax Cuts and Jobs Act (TCJA) at the end of 2025, means that more clients than ever are making or contemplating gifts to others.
This article is designed to answer questions from individuals who are interested in making gifts, in terms of what constitutes a “gift” and what is required of them to do so.
What are the current limits on how much I can give away?
Currently, anyone can transfer money or property to any individual – or to multiple individuals – each year provided that the value of the money or property transfer does not exceed an amount known as the “gift tax annual exclusion,” which is set at $18,000 per person in 2024 and is slated to continue indexing in the future. Provided that the total amount of gifts to one donor does not exceed $18,000 in 2024, the donor is not required to file a gift tax return, or otherwise report the gift to the Internal Revenue Service. It is important to note that if the gift is of a future interest in property, it must be reported on a gift tax return regardless of the amount.
As an example, suppose Joe and Susan, a married couple, wish to give their daughter, Jennifer, $30,000 in cash in 2024. They write her a check for $30,000, which Jennifer cashes before the end of the year. Since the gift is below the amount that Joe and Susan can give her in combination – $36,000 ($18,000 x 2) – this gift qualifies for the gift tax annual exclusion. If Joe and Susan make no other gifts in 2024, they are not required to file a gift tax return.
Once the amount of a gift exceeds the amount of the gift tax annual exclusion, this means the donor has made a “taxable gift.” However, it is likely they will not have to pay gift tax. This is because each taxpayer has a credit against the gift tax. This credit, which applies to gifts made during lifetime or at death, is known as the gift and estate tax exemption. In 2024, the gift and estate tax exemption is $13.61 million per person, meaning that married donors can collectively make gifts of $27.22 million in 2024 without having to pay gift tax. As has historically been the case, the exemption is subject to indexing, with another increase to be announced in the fall of 2024. While the exact amount of the coming increase is not yet known, it is expected to bring the exemption to approximately $14 million per person in 2025.
Here’s the catch: The amount of the gift and estate tax exemption is currently scheduled to be reduced to approximately $7 million per person as of January 1, 2026, due to the “sunset” of the TCJA. Because of the way the rules work, the excess exemption (e.g., $14 million less $7 million) will be lost unless it is used prior to the start of 2026. Going back to our example, if Joe makes $7 million worth of taxable gifts prior to the sunset, he will have no remaining gift and estate tax exemption come January 1, 2026. Compare that to Susan, if she makes $14 million worth of gifts prior to the sunset, she will also have $0 of exemption remaining, but has instead benefitted from the additional gifts made of $7 million. At a tax rate of 40% (i.e., the current tax rate for gifts or estates above the gift and estate tax exemption), this is a $2.8 million “savings” for her.
When should I make gifts to a trust as opposed to outright to an individual?
For individuals who decide to make gifts of any amount, a common question is typically whether to do so directly to the recipient, or via a trust. While trusts seemingly ramp up the complexity of making a gift, there are many advantages to the donor. Among them are the ability to “control” when and how the recipient has access to the property in the trust (or the income it generates), creditor protection from creditors and provisions that take into account changes in circumstances, such as special needs or substance abuse.
Let’s revisit our example of Joe, Susan and their daughter, Jennifer. However, instead of writing her a check directly, Joe and Susan decide to establish a trust for her benefit and make the gift to the trust. In order for gifts to a trust to qualify for the gift tax annual exclusion, and not be considered a gift of a future interest in property, the trust agreement must provide Jennifer with the ability to withdraw the amount contributed to the trust after receiving notice of the contribution. This withdrawal power is commonly referred to as a “Crummey” power and is named after a case litigated on the matter.
How does the IRS keep track of how much a donor has given away?
The use of the gift tax exemption is tracked by the IRS when a donor files a gift tax return (Form 709). Where donors have made gifts in multiple years, Form 709 calculates the overall amount of gifts, the corresponding use of gift and estate tax exemption and the remaining exemption.
What is the generation-skipping transfer tax?
In addition to the gift and estate tax regimes, there is a third tax that applies to certain gifts. This occurs when a donor makes a gift to someone who is two or more generations below the donor, or more than 37 ½ years younger. This tax is known as the generation-skipping transfer (“GST”) tax. Like the gift and estate tax exemption, the GST exemption is currently $13.61 million per person in 2024. Taxable GST transfers above the exemption are also taxed at 40%. The GST exemption is applied and tracked separately.
Joe and Susan, from earlier, create an irrevocable trust for the benefit of their daughter, Jennifer, and their granddaughter, Jenna, and make gifts to the trust of $7 million and $14 million, respectively. The decision to allocate the GST exemption to the gift will ultimately depend on how the trust is designed to benefit Jenna. Let’s assume that Joe’s and Susan’s tax professionals recommend allocating GST exemption to the gift. In this case, the results are as follows:
Gift and estate tax exemption
Joe: Uses $7 million of gift tax exemption
Susan: Uses $14 million of gift tax exemption
GST exemption
Joe: Uses $7 million of GST exemption
Susan: Uses $14 million of GST exemption
If Joe and Susan decide not to allocate the GST exemption, or perhaps have already used it, they can still make the gifts to the trust. However, this means that for every dollar that is distributed to Jenna, the GST tax will apply to distributions to her at the current rate of 40%.
What if a donor lives in a community property state?
If a donor is a resident of any of the following states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin – any property they acquire after getting married (other than property received by gift or bequest) is considered “community” property, meaning that half is considered to be owned by each spouse. Anything that is not community property is “separate” property of the donor alone. Non-community property states are typically referred to as “common law” states.
In our earlier example, if Joe and Susan are residents of California and consider making the same gifts ($7 million from him and $14 million from her), they will need to determine whether the assets they are each giving away are community property or separate property. If Joe’s $ 7 million and Susan’s $14 million are confirmed to be separate property, the results will be the same as above. However, if the assets given away are instead community property, then despite the intent for Joe to give away $7 million and Susan to give away $14 million, the total amount of gifts is deemed to come 50% from each. This results in Joe using $10.5 million of his gift tax exemption and Susan using $10.5 million of hers. Since this result is not in line with their intent, Joe and Susan should work with their attorney prior to making gifts on converting the community property to the separate property of each spouse.
What is gift-splitting?
Gift-splitting is an election that allows married donors to “combine” their gift tax exemptions for a given year. To do so, both spouses must consent via Form 709.
In the prior example, if all the assets being given away belong to Susan and are not, in fact, community property, gift-splitting can allow them to accomplish the goal of making gifts of Susan’s separate property, while also relying on Joe’s gift tax exemption. If Joe and Susan split gifts on Form 709, of the $21 million worth of Susan’s assets given away, $10.5 million of each spouse’s gift tax exemption (and GST exemption, if allocated) will be used.
Is there a statute of limitations for gifts like there is for income taxes?
There is a three-year statute of limitations for gifts adequately disclosed on Form 709. This means that if the donor meets all the necessary requirements for disclosure on a properly filed on Form 709, the Service cannot challenge those gifts after three years from filing. If gifts are not adequately disclosed, the statute will remain open.
At a high level, adequately disclosing a gift on Form 709 requires the following elements:
- A description of the property transferred;
- The identity of the person giving the property away and the person receiving the property;
- If the gift involves a trust, provide the trust’s Employer Identification Number (EIN) and a description of the trust terms or a copy of the entire trust document;
- A copy of any qualified appraisal or a description of the method used to determine the fair market value of the property; and
- If the taxpayer’s position contradicts any existing Internal Revenue Service regulations, this must be disclosed and explained.
How should the fair market value of a gift be determined?
Outside of cash or marketable securities, which are typically easy to value, determining the fair market value of other gifts requires a qualified appraisal or a description of the method used. This includes, but is not limited to, gifts of closely-held business interests, real estate, collectibles, artwork, alternative investments, etc. A qualified appraiser should be engaged to prepare a qualified appraisal of the property, and a copy of the appraisal should be attached to the gift tax return. The appraisal should be dated as of the gift date.
What else needs to be reported on a gift tax return besides gifts?
In addition to gifts, it is recommended that other gift tax-related transactions be reported on Form 709 to get the statute of limitations running. One example is an installment sale to an Intentionally Defective Grantor Trust (IDGT), where the grantor of an IDGT sells property to the trust in exchange for a promissory note and payments over time. Another is where the grantor has the right to exercise a power of substitution and “swap” personally owned assets for trust assets of equal value. While these are not gifts, many tax professionals will recommend reporting these transactions on a Form 709 for the year of the transaction.
Questions? Connect with our team to learn more.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
