Know The Four Ways To Make Tax-Free Gifts


Estate taxes aren’t a widespread concern today but will be if Congress changes the rules or lets the 2017 tax law expire at the end of 2025, as is currently scheduled to happen.

A good way to reduce or eliminate estate taxes is to reduce the value of your estate by making tax-free gifts. Smart gift giving also can reduce your lifetime income taxes.

There are four ways to make tax-free gifts.

You can make qualified education and medical gifts in unlimited amounts. Give as much as you want on behalf of as many people as you want each year. Only a few simple requirements need to be met.

Qualified education gifts pay for direct tuition costs and not for items such as books, supplies, board, lodging, or other fees. The gifts must be made directly to an education institution. The payments can be for any level of education and regardless of the beneficiary’s relationship to you.

A qualified medical gift is any expense that would be deductible as a medical expense on Schedule A of the individual income tax return if paid for by the individual receiving the services. Deductible medical expenses are fully defined in free IRS Publication 502, available free on the IRS web site.

The payments must be made directly to the medical care provider.

Next, consider gifts that qualify for the annual gift tax exclusion. Gifts can be of either money or property of up to $17,000 per recipient during the year.

You can make gifts up to the year’s exclusion limit to any individual without any estate or gift tax consequences. Gifts that quality for the annual exclusion won’t count against your lifetime estate and gift tax exclusion. The recipients won’t owe any federal taxes on the gift or gifts. Qualified education and medical gifts don’t count against the annual gift tax exclusion.

You can make these gifts to as many people as you want during the year, with a separate annual tax-free limit for each person. A recipient doesn’t need to have any family or other relationship with you.

Only gifts of “present interests” qualify for the exclusion. Basically, this means any gift with strings attached or other limits doesn’t qualify. You must transfer full legal title to the property.

An exception is known as the Crummey trust power. This power allows a trust beneficiary to withdraw a gift from a trust within a certain period, usually at least 30 days, after the gift is made. If the beneficiary doesn’t request a distribution, the money stays in the trust and is managed and distributed under the terms of the trust.

You can make additional tax-free gifts using the lifetime estate and gift tax exemption.

The lifetime exemption amount in 2023 is $12.92 million. Amarried couple has a combined $25.84 million exemption.

Any gifts you make during the year that exceed the annual exclusion and don’t qualify as qualified medical and education gifts count against your lifetime exemption.

After making these gifts, you file a gift tax return and use part of your lifetime credit to eliminate the gift tax. To the extent your lifetime exemption isn’t used against taxes on lifetime gifts, the remainder is used to reduce estate taxes.

In 2021 several proposals to reduce the lifetime estate and gift tax exemption failed to pass Congress. Even if none of these proposals is enacted, the current exemption amount is scheduled to be cut in half after 2025 when the 2017 tax law expires.

In your estate planning, consider the possibility the exemption might be reduced by either an act of Congress or expiration of the 2017 law. If your estate might be taxable after the exemption is cut in half or less, consider reducing the size of your estate in the next few years by making gifts.

Even if the lifetime exemption is reduced in the future, gifts that were tax-free when they were made shouldn’t become taxable. The IRS has issued some guidance affirming the gifts won’t become taxable.

The fourth way to make tax-free gifts is to give money or property to your spouse. Gifts between spouses are tax free without limit. Spousal gifts aren’t as valuable now that unused estate tax credits can be transferred to the surviving spouse. But you should know that all gifts to your spouse will be tax free.

Taxable gifts can be reduced further using sophisticated strategies that reduce the value placed on gifts, such as grantor annuity trusts, family limited partnerships, and more. A good estate planner can help decide if any of these strategies is appropriate for you. Be advised there are proposals in Washington to limit or repeal these strategies. The IRS issued proposed regulations in 2016 to restrict the strategies, but they later were withdrawn. Individuals whose estates exceed or are close to the current exemption level should consider using these strategies while they still are available.

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