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Estate Planning 101: Making Exempt Gifts

older man holding a baby overhead
Posted on June 7, 2022 by Denver Gant

I have yet to meet a client who wants to pay estate taxes. Tax avoidance is among the primary reasons people meet with estate planning attorneys and develop estate plans. In 2022, the federal gift, estate, and generation skipping transfer tax exemptions are $12,060,000 per person (which is indexed for inflation and will rise through 2025) and $24,120,000 per married couple. Estates larger than the federal exemption amount face a 40% estate tax. Accordingly, not many single people or married couples need to plan to reduce or avoid the federal estate taxes. In 2022, the Washington estate tax exemption is $2,193,000 per person. Taxable estates in excess of the Washington exemption face a graduated tax of 10% to 20%. Due to the significantly lower exemption amount, the Washington estate tax is of larger concern for Washington citizens, especially as real property values continue to appreciate at a rapid pace. Notably, Washington only has an estate tax, so gifting during one’s lifetime can be an effective strategy to avoid the tax.

The initial meeting with an estate planning attorney typically involves exploring strategies to mitigate or eliminate the estate tax through gifts. Gifts of high amounts obviously can achieve this purpose faster but will trigger the need to file a federal gift tax return called a Form 709. Filing a 709 does not mean gift taxes are owed unless the donor has surpassed their lifetime federal exemption (at which point there is a 40% gift tax). Instead, the 709 alerts the IRS to the gift and provides the cumulative value of property or properties. The value of the gift reduces the amount of the donor’s exemption on a dollar-for-dollar basis. For example, if a mother gives her daughter $1,016,000 in 2022, the mother’s remaining lifetime exemption would be reduced by $1,000,000 (see below about the $16,000) to $11,060,000 (assuming she has not used the exemption before). CPAs typically prepare the Form 709, which has certain requirements for valuing a gift that may result in the need for an appraisal of an asset or valuation of a business interest to establish the value. This can be a somewhat costly and cumbersome process but is well worth the time and effort due to the significant estate tax savings.

There are a few ways to make gifts that do not require the filing of a Form 709. While these types of gifts do not result in immediate, substantial reductions in the size of an estate, these types of gifts can make a sizable impact as part of a sustained gifting strategy.

Annual Exclusion Gifts

The most frequent method to make gifts is the use of the annual gift exclusion. The annual exclusion applies to a small, cumulative amount donors can give to any donee (other than their spouse because there is unlimited gifting between spouses) during a calendar year. As long as a donor does not give a donee an amount above the annual exclusion, there is no need to report these gifts on a Form 709. The amount of the annual exclusion is indexed to inflation, and it rises over time. Between 2018 and 2021, the amount was $15,000 per year per recipient, and rose to $16,000 as of January 1, 2022. Parents can give up to $32,000 per year ($16,000 for each parent) to each of their children and can double that amount if the child is married and they trust the child’s spouse (a completed gift is legally the separate property of the donee).

Not all gifts qualify for the annual exclusion. The most important requirement is the gift must be of a present interest in the gifted property, meaning the recipient must be able to immediately access the gifted property. For example, a $1,000 gift to a niece to help purchase a car is a present interest, but a gift to a trust for that same niece that will be distributed to her in five years is not a present interest and would not qualify for the exclusion. Care should be given if the gift is a check made very late in a calendar year. If the donee cashes the check on or after January 1, the gift may be counted as having been completed in the subsequent year.

Children under the age of 18 are legally incapacitated and cannot own property, but they can receive annual exclusion gifts in several ways. A trust that has special withdrawal provisions, called Crummey Powers, can transform a gift that likely will be used in the future into a present interest. The gift can also be made in the child’s name to a Uniform Transfer to Minors Act account where a custodian (frequently the parent) controls the investment or management until the child reaches a certain age, commonly 18 to 25.

Contributions to 529 Programs

Gifts to a 529 college savings plan to help pay for current or future education expenses for a child or grandchild also qualify for the annual exclusion, even if the donated property may be used well into the future. The IRS also created a special election that allows for superfunding contributions to 529 plans. Donor can make a lump sum contribution of up to five times the current annual exclusion and prorate the contribution over five years. If the donor does not give additional amounts during that five-year period, the entire amount qualifies for the annual exclusion during those five years. As a result, $80,000 in contributions can be made to 529 plans in 2022. Unlike other annual exclusion gifts, donors need to file a Form 709 and then make a specific election to superfund the plan.

Direct Payments to Medical or Education Institutions

Another option for making gifts that do not need to be reported on a Form 709 is education or medical expense payments made directly to the institution or organization. These payments made on behalf of a donor are exempt from the gift tax and the amounts can be unlimited. For education expenses, the payment must be for tuition only (not room and board or books) and be made directly to the school. The schools that qualify for this exemption include post-secondary institutions and private elementary, grade, middle, junior, or high schools. For medical expenses, the payment must be made directly to the health care provided or a company that provides medical insurance.

Capital Gains Considerations

The income tax treatment of gifted assets versus inherited assets should factor into the selection of assets to gift or hold onto until death. When a person passes away, the basis of nearly all of their assets steps up to the value as of the date of their death. For gifted assets, the donor’s basis carries over to the donee. For example, if a parent gifts their child a $500,0000 residence they purchased for $250,000, the child faces a capital gains tax on the $250,000 difference between the basis and value of the asset if it is sold immediately. But if that same residence is left to the child at the parent’s death, the child’s basis will be $500,000 and there would be no capital gains taxes owed upon an immediately sale. Due to the carryover basis of gifts, special consideration should be given to the form and type of assets to gift.

The Estate Planning Attorneys at Lasher Holzapfel Sperry & Ebberson PLLC are available to help you formulate gifting strategies and select the best assets to gift to mitigate or avoid federal and Washington estate taxes.