I love Christmas! Family together, Santa and kids, the music, eggnog (with rum of course), shopping for deals, parties, and of course the birth of Jesus Christ. I love it all! So, despite everything that has happened so far in 2020, they still haven’t canceled Christmas yet (as of this writing). That means this past weekend, I happily followed my wife, Jill’s, instructions, and to-do list on which decorations to bring up from the basement and deploy throughout the house. It also means I am being told by all three of my girls to not ask for another boring present, like a sweater or a pair of wool socks this year.
The upcoming December holidays also brings calls from clients about gifting money or spreading assets to their kids or grandkids. Most of us think of estate planning as preparing for what we want to happen to our assets and money after we pass away. And, for the most part that’s true. It’s critical to check the important boxes like a will, a chosen executor, a potential trust, and a health care directive. But, this time of year should also be a reminder that giving gifts from our estate while we are alive, can also be part of an estate plan. So, this week I thought it helpful for us to look at some of our options as we approach the end of the 2020 tax year.
With gifting there are multiple considerations, both financial and emotional. First and foremost, and it may seem like common sense, but you need to ensure that you can afford to give the gift away. All of your retirement income needs, including potential health care and long-term care costs associated with retirement need to be accounted for. It’s important that the gift you give doesn’t mean risk for you, or that you might even need to ask for it back someday.
From a tax standpoint, there are IRS legal restrictions that you will need to follow to prevent a tax liability. Everyone has a lifetime IRS exemption of $11.58 million until the end of 2020. That number grows to $11.7 million as of 2021 and this amount doubles for married couples. People with larger estates might want to consider gifting in the near term. A consideration for gifting sooner rather than later is because the estate tax exemption reverts to $5 million in 2026. With the ongoing national debt crisis, it seems unlikely that the current level of the exemption will be sustained at the higher level.
Beyond the lifetime exemption, the IRS currently allows anyone to gift anyone else an annual amount capped at $15,000 on an annual basis. For married couples that amount is doubled to $30,000. This gift is not taxable to the receiver of the gift. Any gifts above the $15,000 annual individual limit or $30,000 married couple limit count against the lifetime exemption I mentioned earlier. Another thing to think of here is that you are also allowed to make a tax-free gift in any amount to anyone for medical or college expenses.
Another key question I hear often is if gifts should be in cash or can you instead gift assets, such as a home. Generally speaking, when looking at purely a tax liability perspective, the preferred method for gifting is cash. Giving non-cash gifts like real estate could create significant potential tax exposure. For example, generally, if you gift a home while you are alive, there is no step-up in basis for the receiver. For tax purposes, the receiver of the gift will need to value the gift at the original purchase (or cost basis) price the giver bought it for. In this case, let’s say you give somebody a home with a $750,000 current fair market value while you are still alive that you bought for $50,000 as a young newlywed. The receiver only gets the tax basis of the original purchase price of $50,000. This means if they sell it in the future, they will have to pay tax on anything above the $50,000, resulting in a potentially hefty tax bill. The same home received by an heir as part of a will upon death gets a step up in basis meaning the tax basis would be the $750,000 fair market value. If they then sold the home after inheriting it, they would only owe tax on anything above $750,000.
Even those without large estates could face substantial issues if they give away their home or gifts to a child while they are alive. Anyone who may need Medicare for long-term care services will face a five-year look back in calculating their eligibility for Medicare. Creditors can also create problems when you give away any gift while you are alive, with the gift becoming potentially exposed to creditor claims even after it has been given.
All of these financial considerations aside, there are emotional and psychological aspects of giving away money to your kids or grandkids while you are still alive. There is the joy of seeing your loved ones get the gift while you are both there to enjoy it. You also can also offer timely help to a loved one attempting to achieve a goal or dream that fits a certain timeframe in their life, such as college or marriage.
Finally, giving smaller gifts to your children or grandchildren while you are still alive may give you a good indication as to how responsible they are with gifted money. Do they spend or invest it wisely? Did the gift actually result in a degree? Has the money been successfully and responsibly invested? Often how well your gifts are used can help you make decisions on things like your trusts and what type of control you may want to exercise over your estate after you have passed away.
Folks, it’s certainly been a crazy year, but I hope . . . and I pray you find comfort and joy with your family and friends this holiday season. Because, you know, that is the absolute greatest gift we can give.
And as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at firstname.lastname@example.org.
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