Last Updated on August 15, 2024 by Chris Franchina
Last Updated: August 15th, 2024
Gifting & Taxes
Did you know that gift-giving can have tax implications? It’s important to have a little knowledge about gift tax to ensure that your generosity doesn’t come with any unexpected financial consequences. Additionally, we will be taking a look at the gift-funded life insurance strategy.
Understanding Gift Tax:
What is Gift Tax? Gift tax is a federal tax on the transfer of money or property from one person to another without expecting something of equal value in return. While the recipient of the gift doesn’t pay taxes, the person giving the gift might have to.
Who is Subject to Gift Tax? In simple terms, gift tax is typically paid by the person making the gift, not the person receiving it. However, not all gifts are taxable. The IRS allows for an annual exclusion amount (cutoff in 2024, it’s $18,000 per recipient), meaning you can give gifts up to this amount to as many people as you want without incurring any gift tax.
When to Use Gift Tax:
Estate Planning: One of the primary reasons for considering gift tax is estate planning. By gifting assets during your lifetime, you can reduce the overall value of your estate, potentially lowering estate taxes when you pass away.
Financial Planning: Gift tax can also be a useful tool for financial planning. Parents, for example, may choose to gift money to their children for educational expenses or to help with the purchase of a home.
When Not to Use Gift Tax:
Small Gifts: Gift tax is not a concern for small, everyday gifts. Gifts under the annual exclusion amount are not taxable, and you don’t need to report them.
Spousal Gifts: Gifts to your spouse are generally not subject to gift tax. There is an unlimited marital deduction for gifts between spouses who are U.S. citizens.
Gift Tax:
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- You can now make gifts of up to $18,000 in 2024 without paying gift taxes. In 2023, the limit was $17,000.
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Gift Tax Exemptions:
- The annual gift tax exclusion for 2024 is $18,000 per recipient. This means you can give up to $18,000 to as many individuals as you want without triggering gift tax or reducing your lifetime estate tax exemption.
- Payments made directly to medical or educational institutions for someone else’s expenses (qualifying tuition and medical expenses) are still not considered taxable gifts, even if they exceed the annual exclusion amount
Gift Splitting:
- Married couples can combine their annual exclusions to gift up to $36,000 per recipient in 2024 through gift splitting. This allows them to make larger gifts without incurring gift tax.
Impact of Appreciated Assets: When you gift appreciated assets, the recipient inherits your cost basis. If you gift stock that has appreciated in value, the recipient may be subject to capital gains tax when they sell it. For instance, if you gift stock worth $20,000 that you bought for $10,000, the recipient may owe capital gains tax on the $10,000 gain.
Gifts to Non-U.S. Citizens: Gifts to non-U.S. citizen spouses are subject to special rules. In 2024, you can gift up to $164,000. annually to a non-citizen spouse without triggering the gift tax. For example, you can give your non-citizen spouse $164,000 if you are a U.S. citizen. without facing gift tax consequences.
Gift Tax Returns:
- You are required to file a gift tax return (Form 709) if you give gifts that exceed the annual exclusion amount. However, you won’t necessarily owe gift tax at that time unless your lifetime gifts exceed the exemption amount.
Lifetime Gift Tax Exemption Planning:
- The lifetime gift and estate tax exemption for 2024 is $13.61 million. This means you can give away up to this amount over your lifetime without incurring gift or estate tax.
Consequences of Ignoring Gift Tax:
- Failure to file a gift tax return when required or inaccurately reporting gifts can lead to penalties and interest charges.
Gift Tax and State Laws: State laws can vary, and some states have their own gift tax rules. For example, Connecticut and Minnesota have their own gift tax. If you live in one of these states, you may need to adhere to both federal and state regulations when making gifts.
Seeking professional advice is crucial for effective gift tax planning. A tax advisor can help you navigate complex regulations. For instance, if you plan to make large gifts as part of your estate planning, a financial advisor can guide you on the most tax-efficient strategies.
Imagine leaving a significant financial legacy for your loved ones while minimizing taxes.
With the Gift-Funded Life Insurance Strategy!
The Big Idea:
- You gift money (up to the annual IRS limit of $18,000 per person in 2024) to a designated recipient.
- The recipient uses this gift to pay premiums on a life insurance policy with you as the insured.
- Upon your passing, the beneficiaries receive the death benefit, free of income tax.
What is the Strategy?
A creative and often underutilized approach in financial planning involves gifting money within IRS limits to fund life insurance policies. This strategy is particularly beneficial for those looking to provide a substantial financial benefit to their heirs while managing their own taxable estate.
- Gift up to $18,000 per recipient per year (2024 limit) without triggering gift tax or reporting to the IRS.
- Recipient uses the gift money to pay premiums on a life insurance policy on your life.
- Policy ownership:
- Individual recipient: Simple setup, but less control for the donor.
- Trust: Offers more control and flexibility, but adds complexity and fees.
- Tax-free benefits:
- Beneficiaries receive the death benefit free of income tax. If structured correctly, the beneficiaries can receive the life insurance proceeds free of income tax. Additionally, because the policy is not owned by the insured (the original donor), the proceeds are typically not included in the donor’s estate, potentially reducing estate tax liability.
- Life insurance proceeds are not included in your taxable estate (if structured correctly), potentially reducing estate taxes.
Benefits of the Strategy
- Estate Tax Reduction: By gifting money, you reduce the size of your taxable estate, potentially lowering estate taxes.
- Leveraging Gifts: Even small annual gifts can accumulate and lead to a significant payout through the life insurance policy.
- Flexibility and Control: You retain control over the annual gifting, allowing you to adjust based on your financial situation.
- Efficient Wealth Transfer: This strategy provides a tax-advantaged way to pass on wealth to your heirs outside of the traditional estate process.
Considerations for Implementation
- Professional Advice: Consult with financial and legal professionals to ensure compliance with tax laws and regulations and to align this strategy with overall financial and estate planning goals.
- Long-Term Planning: This strategy requires a commitment to annual gifting and, depending on the life insurance policy, potentially long-term premium payments.
- Trust Structure: If a trust is used, additional considerations, such as the type of trust and administrative requirements, come into play.
Who can benefit from this strategy?
- Individuals with a significant taxable estate who want to reduce potential estate taxes.
- Those seeking to provide a substantial financial legacy for their heirs.
- People who want to have more control over their wealth distribution.
The information provided is for general informational purposes only and should not be considered professional tax or financial advice.
