One of the most common questions I get on a daily basis is about annual gifting. In particular, clients ask about giving away $14,000 a year.
Can you? Should you? Are you limited to that amount? How does that affect taxes?
In response to these questions, I have to ask another: Do you have over $2 million?
If you have less than $2 million
If you have less than $2 million, then you don’t need to worry about gift tax. You can give away as much as you want and pay no tax. My clients are relieved to hear this, but also a little confused.
If I’m not limited to $14,000 gifts, then why do I keep hearing about it?
It is a common misconception that all people are limited to annual gifts of $14,000 per year. It is true that everyone, including you, me, and Warren Buffet, can give away $14,000 per person per year tax-free.
That means that I can hand $14,000 in cash to every person I see at the supermarket until I run out of money and I won’t pay any gift tax. However, for most people, this misses the larger point. As of 2017, every person also has a $2 million lifetime exemption amount in Connecticut, and a $5.49 million lifetime exemption (indexed annually for inflation) for federal taxes. Rather than spread my wealth around at the supermarket, I can give $2 million to one very lucky shopper, and I still pay no gift tax!
But what if you do have over $2 million?
In that case, making $14,000 (or $28,000 for a married couple) tax-exempt gifts per year is a smart way to reduce the size of your taxable estate. Giving away more than this amount will incur gift tax or eat into your estate tax exemption for the amount over the annual exemption. Under federal and Connecticut law, the gift tax and estate tax systems are unified, which means that the same credit applies to both types of taxes.
Here is how that works in practice. Let’s say you have $2.5 million and you give away $1 million to your daughter. You have used $986,000 (after subtracting the $14,000 annual exemption) of your $2 million estate and gift tax credit. You only have a little over $1 million left to use, but you still own $1.5 million when you die. The difference (a little less than $500,000) is exposed to Connecticut estate taxes.
Remember that Connecticut estate tax rates are between 7.2% and 12% of the amount over the exemption, and the federal estate tax rate is 40% of the amount over the $5.49 million exemption. A large gift can therefore expose yourself to greater estate taxes when you die. Not only that, but making a taxable gift also requires the filing of a gift tax return, which means extra costs for an accountant.
Now, let’s say that instead of giving $1 million to your daughter in one lump sum, you give $14,000 to ten different people every year for ten years. You will have spent $1,400,000 in total, and paid no gift tax on any of it. You will have also reduced your total estate from $2.5 million to $1.1 million. Now you have a non-taxable estate when you die.
Begin gifting early
Individuals with over $2 million in assets should begin an annual gifting plan if they have not already. If you have less than $2 million, you may want to make annual gifts too, just to be safe.
The $2 million exemption has been constant for several years, but it could change soon. Governor Malloy just proposed an increase in the exemption to $2.6 million in 2018, $3.6 million in 2019, and to the federal exemption amount (currently $5.49 million) in 2020. That is good news for taxpayers, but it would also generate less revenue for a State with perpetual budget woes. If the legislative needs to collect more revenue in the future, it could just as easily lower the lifetime exemption amount to $1.5 million or even $1 million.
Gifting and Medicaid
Finally, the $14,000 rule does not apply for Medicaid. The State may scrutinize any gifts you made over the past five years over $1,000, and large gifts can trigger significant penalties.
If you want to move assets out of your name, there is a right way and wrong way to do it, and we recommend calling us if this is your goal.