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Gifts And Their Tax Consequences
There is always a great deal of confusion about making gifts. Some
people think it is a tax deduction for them on their individual tax
return. Others think it will cost them income tax if they give
money. Most wonder if they have to record this gift with the
government in some form or another. Here's a quick overview of the
2000 IRS rules and regulations of making gifts.
Income Tax Vs Estate Tax
First, understand that there are two major forms of federal taxes
people face: Income taxes, and Estate taxes. Income taxes refer to
the moneys owed the government based on how much taxable income you
make each year. Estate taxes refer to taxes your estate may owe upon
your death based on the net assets you have. In effect, it is a tax
on your net worth, not your income.
How does a gift come into play? In a nutshell, gifts do not directly
impact your income tax liability. Thus, you will not save any income
taxes, nor can you deduct a gift on your income tax return if you
make one to an individual. Nor will you owe any income taxes if you
make a gift.
However, making gifts may affect your estate tax situation, either
positively or negatively, depending on the type of gift, and the
size of your estate. This is because of the way gifts over a certain
size are handled by the laws. In effect, it "lumps" them together
over a cumulative period so that making a gift may affect your
overall estate tax filings and liability.
How Big A Gift Can You Make?
A taxpayer gets a break on making annual gifts. Under current
federal 2000 rules, a person can give up to $10,000 per
year(adjusted annually for inflation), per person without any
consequences, and without generally being required to file any gift
tax return. A married couple can jointly give $20,000 per person
without it creating a taxable event.
Beyond this amount however, complications arise. If you give more
than $10,000 per person per year, you are then required to file a
Gift tax return which is due by April 15 of the year following the
gift date. This gift amount may then be subject to a tax, depending
on the cumulative value of all prior taxable gifts. In effect, you
are running a balance with the government until you reach certain
limits. How much are these limits? You have a "Unified Credit" with
Uncle Sam which allows you to leave a cumulative total of $675,000
to beneficiaries through either your estate and/or cumulative gifts
exceeding the previously mentioned $10,000 per year per person.
As an example, if you give someone $25,000 in one year, the rough
calculation works like this. The first $10,000 is not subject to
tax. The remaining $15,000 must be recorded as a reduction in your
allowable $675,000 exemption equivalent. You pay no tax now, but it
may be subject to a tax in later years if you exceed the remaining
balance of the $675,000 exemption.
What tax rate will you pay on this gift in excess of $10,000 per
year? It depends on the amount by which you eventually exceed the
$675,000 exemption. When your combined taxable gifts and net estate
value(at death) exceed this exemption, the tax rate can rise
rapidly. It starts at 37% and can reach 55% at the upper levels
quite rapidly, so it is a potentially stiff tax.
There is an exception to this $10,000 per year figure, however, if
you are directly paying for educational costs on a secondary level,
or medical expenses for a person.
Using Gifts For Estate Planning
Making gifts can therefore be used to save on estate taxes. If you
know your overall net worth will exceed $675,000 at death, you can
make use of the $10,000 annual exclusion to reduce your estate, and
therefore save taxes down the road. If you have a large estate, the
savings can amount to upwards of 55 cents on every dollar given
away. As you can see, it can be a very important tax-saving tool, as
well as being a very nice thing to do!
Non-Cash Gifts
A common misconception occurs when it comes to making non-cash
gifts, and it is important to set the record straight. This issue
frequently involves giving stocks or property. When a gift of this
nature is made, the value of the gift for reporting purposes, and
for gift/estate purposes is usually the fair market value at the
date of the gift(there are exceptions if the gift has depreciated in
value since its acquisition). So, if you give your daughter a house
currently worth $200,000, that's the gift figure you must use when
you file the gift tax return.
However, when your daughter then sells the property, her basis for
tax purposes may be different. In most situations, the basis she
must use for determining whether or not she has a capital gain is
your original basis(plus any capital improvement costs), not the
fair market value at the gift date. Thus, if the house you give her
only cost you $25,000, your daughter must use this figure and pay
taxes on the difference.
Thus, gifting assets that have appreciated in value requires proper
planning. You must coordinate this activity with your overall estate
planning, and with the tax bracket of the recipient if they
anticipate selling the property.
The moral of the story? Consult your financial and/or legal advisors
before making any gifts exceeding $10,000 per year per person, and
especially if the gift consists of appreciated property, like real
estate or stocks. Small fortunes in taxes can be lost with improper
planning in this area.
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