How To Share Your Wealth With Your Family Without Giving The IRS A Cut

If you are like many of our clients, one of your top joys and goals in life is being able to provide for your family. Today we want to talk about how to take it to another level and how it can be both emotionally and financially better to begin giving some of your wealth towards your family today versus upon your passing.

For our clients whom have been able to accumulate more wealth than they will most likely need in their lifetime, we dive deep into talking to them about what their lifetime family and legacy goals are. Many have shared with us that while they want to provide for their kids and grandkids after they have passed, they really would like to pass along some of their wealth while they can see their family enjoy it. During these conversations we analyze how much and how often they can and should “gift” assets to their family. We have summarized how best to do that and the various rules you need to be aware of.

What rules apply?

The IRS, which is the government organization that oversees and cares about the transfer and gifting of assets, allows for a lifetime tax exemption on gifts and estates up to a certain limit, which is adjusted yearly to keep pace with inflation. This was a big topic in 2018 when the limits were increased but many may have missed that these limits are not just applicable to their estate but to their “lifetime gift”.

For 2020, an individual’s combined lifetime exemption from federal gift or estate taxes totals $11.58 million. If married, the joint exemption is $23.16 million. (These limits do not apply to spouses that are both U.S. citizens, as they also have an unlimited exemption from property they inherit from their spouse.)

You are allowed to use all or part of your gift and estate tax exemption during your lifetime. But, any portion left over will then be used by your heirs to reduce or eliminate estate taxes that might otherwise be owed. That can be a really big deal for your heirs, as the top federal estate tax rate currently stands at 40%.

Even if your gifts use up your entire exemption, your loved ones could still come out ahead—they would get your generous tax-free today and could take advantage of its potential for growth. However, there are specific gifting strategies you can use today that can reduce the size of your taxable estate and leave your gift and estate tax exemption untouched (we will cover in another article soon).

But what if you want to enjoy giving today and also save your family money down the line?

How to give today without hurting your lifetime or estate tax exemption

There is an annual $15,000 gift tax exclusion for assets you give to individuals—also indexed to inflation—separate from the lifetime gift and estate tax exemption. By utilizing this gift tax exclusion, not a penny of your gift counts against your $11.58 million lifetime gift and estate tax exemption. And because annual gifts reduce the size of your estate, they reduce the potential tax liability for your heirs.

You’re allowed to individually give that amount to as many people as you like. If married, you and your spouse may each give $15,000 to a particular individual, for a total annual gift of $30,000. For example, a married couple could give $30,000 to an adult child and $30,000 to each of their three grandchildren, for a total of $120,000 each year.

Even though you and your spouse would be combining both $15,000 exclusions, this strategy is called “gift splitting.” And although you won’t owe any additional taxes to the IRS, splitting gifts may still require you to file a gift tax return—Form 709—for the purpose of documentation.

Making a $15,000 annual gift can also be incredibly easy. Unless you and a spouse are gift splitting, you don’t need to file a gift tax return. Recipients typically owe no tax and aren’t required to file any special tax forms.

What happens if you go over the annual gift tax exclusion? 

Now, let’s imagine you give two grandchildren $20,000 each this year, and you give a family friend $12,000. The gift to the friend doesn’t trigger any gift tax issues, as it’s within the $15,000 annual exclusion. But the gifts to the grandchildren exceed the exempt amount by $5,000 each and would therefore require some extra steps. 

The amount that was over the $15,000 annual limit would be deducted from your $11.58 million lifetime gift and estate tax exemption. Unless you have already used up all of your lifetime exemption, you won’t actually owe any tax on the gifts to the grandchildren. However, you will need to inform the IRS that those gifts exceeded the annual limit by filing a gift tax return. In this example, your lifetime gift exemption is reduced by a total of $10,000 ($5,000 for each grandchild).

What doesn’t count towards either exemption or annual exclusion?

While the above options are great, there are other ways you can make gifts that both reduce the size of your estate and help your family or friends.

The IRS allows you to provide the following without eating into your exemption or annual exclusion:

• You can pay the medical bills for another individual. (1)
• You can pay the tuition bills of a student. (2)
• You can make a charitable contribution to an exempt organization.

There is no annual limit on the size of these gifts. As far as taxes go, it’s as if those weren’t gifts at all.

There is one VERY important caveat when it comes to medical and tuition bill gifts: the money must go directly to the institutions, rather than to the patient or student you’re helping.

What about 529 plan contributions?

Here’s an area we see potential issues often, as the $15,000 annual gift limit comes back into play. But in this case, the IRS allows individuals to “five-year forward gift” into one student’s 529. This means, in 2020, you can contribution $75,000 into their 529 without issue. But, keep in mind that any additional gifts to that individual during the next five years will put you over the annual giving limit, so your lifetime exclusion will be reduced by the additional amounts.

Also, if you die in the five years after you make the gift, a prorated amount of your gift will get tossed back into your estate, but only for tax purposes. The money you gave stays in the 529 account.

What’s the bottom line

It’s important to remember that while the IRS generally doesn’t care when you make a substantial gift; the timing can make a big difference to your heirs. Giving a smaller amount when your heirs need it and you’re still alive can be more meaningful for everyone than waiting to pass on a larger amount after you’re gone. As always, what matters is what would work best for you and your family.

Also, please use this as a starting point to think about your options and coordinate any strategy with your wealth manager and tax and estate professionals to consider how a giving strategy fits in with your overall plan, and to determine whether it makes sense for you to give now or later.

As always, please reach out with any questions or if you would like to talk more about your financial situation. 

 (1) Medical care includes expenses incurred for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body, or for transportation primarily for and essential to medical care. Medical care also includes amounts paid for medical insurance on behalf of any individual.

(2)Does not include books, supplies, room and board, or other similar expenses that are not direct tuition costs.

Kathmere Capital Management (Kathmere) is an investment adviser registered under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply any level of skill or training. The information presented in the material is general in nature and is not designed to address your investment objectives, financial situation or particular needs. Prior to making any investment decision, you should assess, or seek advice from a professional regarding whether any particular transaction is relevant or appropriate to your individual circumstances. This material is not intended to replace the advice of a qualified tax advisor, attorney, or accountant. Consultation with the appropriate professional should be done before any financial commitments regarding the issues related to the situation are made.

The opinions expressed herein are those of Kathmere and may not actually come to pass. This information is current as of the date of this material and is subject to change at any time, based on market and other conditions. Although taken from reliable sources, Kathmere cannot guarantee the accuracy of the information received from third parties.