Gifting Consequences to Think About

 

Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible and, in turn, the gift recipient sometimes thinks income tax must be paid on the gift received. Nothing is further from the truth. To fully understand the ramifications of gifting, one needs to realize that gift tax laws are interrelated with estate tax laws.

When a taxpayer dies, his or her gross estate (to the extent it exceeds the excludable amount for the year) is subject to estate taxes. The exclusion for taxpayers dying in 2012 is $5.12 million. In addition, there is an unlimited spousal deduction for married couples. The amounts in excess of these exclusions are subject to inheritance taxes as high as 35%. Naturally, individuals want to do whatever they can to maximize the inheritance to their beneficiaries and limit the amount of inheritance tax on the estate. Since giving away one's assets before he/she dies reduces the individual's gross estate, the government has placed limits on gifts, and if those gifts exceed the limit, they are subject to gift tax that must be paid by the giver.

Gift Tax Exclusions – Certain gifts are excluded from the gift tax.

·  Annual Exclusion – This is the annual amount that an individual can give to any number of recipients. This amount is adjusted for inflation, and for 2012, it is $13,000 (increases to $14,000 in 2013). For example, a taxpayer with five children can give $13,000 to each child in 2012 without any gift tax consequences or the need to file a gift tax return. This amount includes all gifts made to the individual during the year, including birthday, holiday, and special occasion presents, as well as one-time gifts of money or property. The taxpayer cannot deduct the gifts, and the gifts are not taxable to the recipients. Generally, for a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the recipient's enjoyment of the gift can't be postponed into the future. There is an exception to the present interest rule where the recipient is a minor and the terms of a trust provide that the income and property may be spent by or for the minor before the minor reaches the age of 21, with the balance going to the child at age 21. This allows parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

·  Lifetime Limit - In addition to the annual amounts, taxpayers can use a portion of the federal estate tax exemption (it is actually in the form of a credit) to offset an additional $5.12 million during their lifetime without gift tax consequences. Note that the $5.12 million is for 2012 and is expected to be substantially lower once Congress decides upon the 2013 rates. However, to the extent this credit is used against a gift tax liability, it reduces the credit available for use against the federal estate tax at the taxpayer's death.

·  Education & Medical Exclusion - In addition to the two dollar limitation amounts listed above, there are two other types of gifts that can be excluded from the gift tax, regardless of the amount given:

(1) Amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual.

(2) Amounts paid by one individual on behalf of another individual directly to a provider of medical care as payment for that medical care. Payments for medical insurance qualify for this exclusion.

Gifts of Capital Assets – Sometimes a gift might be in the form of securities, real estate, or other items that have appreciated in value. In these situations, the gift value is the item's fair market value at the time of the gift. However, when the recipient of the gift sells that asset, he or she will measure his or her gain from the giver's tax basis. For example, a parent gifts 100 shares of XYZ, Inc., worth $9,000 to his or her child. If the parent originally paid $5,000 for the shares and if the child sold the shares for $9,000, the child (the recipient) would be liable for the tax on the $4,000 gain. In effect, the parent (giver) transferred the taxable gain in the stock to the child. This can be beneficial from a tax standpoint if the child is in a lower tax bracket than the parent and isn't subject to the “kiddie tax” rules that tax the child's income at the parent's tax rate.

Gift-Splitting by Married Taxpayers - If the gift-giver is married and both spouses are in agreement, gifts to recipients made during a year can be treated as split between the husband and wife, even if the cash or property gift was made by only one of them. Thus, by using this technique, a married couple can give $26,000 in 2012 to each recipient under the annual limitation discussed previously.

If you have additional questions or would like this office to assist you in planning an appropriate gifting strategy, please give us a call.

Fine-Tuning Capital Gains and Losses

The year's end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Let's consider some possibilities.

If there are losses to date - As an example, suppose the stocks and other capital assets that were sold during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), thereby offsetting those gains with pre-existing losses.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offsetting long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property's value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

If there are no net capital losses so far for the year - If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.

For the reasons outlined above, paper losses or gains on stocks may be worth recognizing (i.e., selling the stock) this year in some situations. But if the stock is sold at a loss with the idea to repurchase it, the repurchase cannot be within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock.

Careful handling of capital gains and losses can save substantial amounts of tax. Please contact this office to discuss year-end planning strategies that apply to your particular situation so as to maximize tax savings.