You can give up to $13,000 per beneficiary each year without incurring a gift tax or needing to report the gift on a tax return. Married couples can transfer a total of $26,000 per beneficiary. In addition, there is a lifetime $1 million exclusion for gifts and inheritances made above the limits, known as the Unified Estate and Gift Tax Credit. Such gifts typically reduce your taxable estate. If you gave in excess of the limits, you will need to file a gift tax return (IRS Form 709) with your income tax return.
These provisions allow most parents to jointly give up to $26,000 a year to each child without incurring gift tax. Likewise, each pair of living grandparents can jointly give each grandchild up to $26,000 a year without incurring gift tax.
There are, however, several exceptions:
5-year Gift Tax Averaging
With contributions to section 529 plans, there is an accelerated gift option that allows a donor to average gifts that exceed the limits over a five year period without incurring federal gift tax. This allows the donor to give up to $65,000 per beneficiary in a single year ($130,000 for a married couple through gift-splitting). The donor may not give additional gifts to the beneficiary during the five year period without incurring the gift tax. If the donor dies during the five year gift tax averaging period, a pro-rata portion of the gift will be included in the donor's gross estate based on the number of years remaining in the 5 year period (not including the year in which the donor died).
If you inadvertently exceed the gift tax exclusion (i.e., your 529 plan and Coverdell Education Savings Account contributions exceeded the limits), you can avoid paying federal gift tax by taking advantage of the accelerated gift option for 529 plans. This lets you average all or part of your 529 plan contributions over a five-year period, thereby reducing the current year's contribution below the limit.
Other Estate Tax Implications
To be removed from your estate, gifts must be complete on the date you die. For example, if you made a gift by personal check but the check was not cashed or did not yet clear your account on the day you die, the funds will be included in your gross estate. A gift by cashiers check, however, does not suffer from this problem because the bank debits your account immediately upon issuing the cashier's check.
Gifts made from a revocable living trust for which you are a trustee will be included in your estate if you die within three years of the gift. Accordingly, it is better to change the title on such a gift from the trustee to your name individually, and only then give the property to the intended recipient.
Any money in custodial accounts for which you are the custodian will be counted as part of your taxable estate. To avoid this, select someone other than you or your spouse as the custodian or trustee.
Gifts of Property
If you give property instead of cash, the beneficiary receives your tax basis in the property. This is in contrast to property transferred through your estate, which receives a stepped-up basis equal to its fair market value at the time of your death. So if your gift has a low tax basis, the beneficiary may incur substantial capital gains when he or she sells the property. For this reason, when giving property it is best to select gifts that have a relatively high basis.
Payments to Colleges are not Deductible
If you use the gift tax exclusion in IRC section 2503(e) to give money directly to an educational institution on behalf of a student, you cannot deduct the money as a charitable contribution. Earmarking the funds for the benefit of a specific individual eliminates your ability to take a charitable deduction. The main benefit of such a gift is it bypasses the $13,000 annual gift tax limit. However, such gifts are generally counted as a resource because section 2503(e) restricts the payment "as tuition". This means they will reduce need-based aid dollar for dollar. In addition, the student must report the amount of the gift as untaxed income (cash support) on the subsequent year's FAFSA.
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