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LOOKING A GIFT "IN THE MOUTH” –
Tax Issues to Consider when Gifting
It is natural for you to want to help your children. It is natural to want to make things simple for your family.
These goals lead many people to transfer some of their investments to their family as a gift. Like many things involving the law it is never that simple. There can be unintended tax consequences when you make gifts.
Income Tax
The most overlooked tax consequence is that if you give a significant asset to your child during your life, your child will lose the possibility of getting a new basis for income tax purposes on your death in that asset. This can be a devastating result if your income tax basis is low in the property you are gifting and the property is now worth a lot more.
Let's review the general rule regarding the tax basis of assets received as a gift versus assets received as an inheritance.
If you arrange your estate so your heirs receive your assets when you die, then the tax basis of most assets your heirs receive will change to the asset's fair market value on your death. If you give that same asset to your heirs before you die, their tax basis in the asset will be the same as your basis in the asset.
For example if you bought a share of stock for $10.00 many years ago and it is now worth $100.00, your basis is $10.00 and the fair market value is $100.00. If you sell the share, you will have to pay income tax on the capital gains of $90.00 ($100.00 fair market value minus $10.00 tax basis).
If you give the stock to someone while you are alive, their tax basis will be the same as yours, i.e., $10.00. If instead you wait and let them inherit the stock from you and the fair market value is $100.00 when you die, that will be their new basis. When they sell the stock, they will subtract $100.00 from the sales price and have much less capital gains tax to pay because they inherited the stock from you rather than received it as a gift from you while you were still alive.
I do an involuntary gasp when I hear someone boast "My parents planned ahead. They gave me the family farm before they died and we didn't have to do a probate." Many times they go on and say "and my grandparents did the same thing by giving the farm to my parents." My heart stops for a second because I realize that in avoiding the $5,000 (plus or minus) cost of a probate they may have cost their family hundreds of thousands of dollars in capital gain income taxes down the road.
So when you make a significant gift to a loved one, stop and think about the potential for capital gains tax. Real estate and corporate stock are typical assets on which capital gains tax will be due on a sale. Savings accounts and bonds are typical items you can give without losing the potential for getting a step-up in basis at death for income tax purposes.
Of course IRA's, 401k's and similar retirement accounts have their own special income tax rules.
Once you have mastered the income tax issues related to gifts you should also consider the issue of gift tax.
Gift Tax
A common gift tax misconception I run into is that people believe if they give away more than $10,000 worth of assets they will have to pay gift tax.
The reality is that you may make gifts totaling up to $5 million during your lifetime without paying gift tax, although such a gift will reduce the amount you can leave free of estate tax on your death. (You should note that anything you give to your spouse -- either during lifetime or at death -- is not subject to gift or estate tax if your spouse is an American citizen.)
In addition to giving away $5 million without paying gift tax, you may also give $13,000 per year (it used to be $10,000 per year but went up to $13,000 in 2009) to as many people as you want without using any of your lifetime gift tax exemption. Most people will never have to pay gift tax because they will never give away anywhere close to the exemption amount; however, unless Congress enacts new legislation, the current gift tax exemption of $5 million is scheduled to decrease to $1 million in 2013.
Medicaid
If you are at a time in your life when you might need long-term care in the foreseeable future, then you should also evaluate any proposed gift to determine how it will impact you ability to qualify for Medicaid.
Conclusion:
It is wise to review your proposed gift with an estate planning attorney before you make a large gift to make sure you are not creating an unintended problem for your family.
(The above should not be construed as specific legal advice and is intended for general information purposes only. The information contained herein was posted June 2011. Please be aware that tax law changes frequently.)
I have been helping Clark County residents with their estate planning and probate needs since 1976. I give frequent seminars in the community to help increase understanding of estate planning issues. My practice emphasizes probate, Medicaid issues, wills, trusts, incapacity issues, guardianships and durable powers of attorney. Phone: (360) 816-2485 Fax: (360) 816-2486
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