For larger gifts, it is important to have a plan that considers tax efficient strategies. Ultimately, there are three buckets your wealth can end up in when planning your legacy: taxes, loved ones, or charity. Good planning will reduce taxes and maximize the wealth transferred to loved ones and charity.
Gift Tax and Gifting to Loved Ones
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The good news is that most families will not need to worry about a gift tax on their estate. Under current tax law, the lifetime gift tax exemption for an individual is $11.7M ($23.4M for married couples), meaning you can give up to $11.7M in your lifetime before paying estate taxes. Gift taxes use the same tax structure and exemption as estate taxes.
This exclusion will revert to 2017 limits ($5.49 million for an individual) adjusted for inflation at the end of 2025. Legislation can always change the exemption amount. so it is important to stay up to date on current tax law.
Annual Gift Tax Exclusion
The annual gift tax exclusion allows you to give up to $15,000 ($16,000 in 2022) without using up any of your lifetime exclusion. This annual exclusion is per person, so if you are married, you and your spouse can give $30,000. It is also per recipient, meaning you and your spouse can give $30,000 to however many individuals you would like without using up your lifetime exclusion.
If you have a growing estate that is likely to run into estate tax problems, the annual gift tax exclusion is a very useful tool. As the exclusion is annual, the earlier it is applied in life, the more effective it will be for your estate. It is never too soon to discuss your estate plan with your financial advisor.
Educational and Medical Expenses
A way around the annual gift tax exclusion is to make direct payments for qualified educational expenses or qualified medical expenses on behalf of a loved one. There is no limit to the amount allowed to be paid; however, direct payments are a key distinction. You cannot reimburse the individual receiving the benefit for these expenses. The payments must be made directly to the institution providing the services.
Additionally, you can use a 529 plan to set aside money for a beneficiary's future educational expenses. The amount contributed will grow tax-free and will not be taxed when used on qualifying educational expenses. Your financial advisor can help you pick a 529 plan in your state that works best for you and your beneficiaries.
Gifting to Charity
When it comes to giving to charity, there are many different strategies, and each can be more or less effective depending on your specific scenario. Below are a couple of strategies that are simple yet effective for most scenarios.
Gifting appreciated assets (i.e., securities or real estate) allows you to avoid the capital gains tax while still receiving a charitable deduction based on the fair market value of the asset. For example, if you purchased stock ABC for $100 and gifted it several years later at a fair market value of $200, your charitable deduction would be based on $200. Neither you nor the charity receiving the gift would owe the capital gains tax on the $100 gain.
Keep in mind that there are different AGI limits for the type of asset gifted (i.e., 30% for appreciated assets). Any excess charitable contributions will roll forward to the next tax year for up to a total of five years.
Consolide Gifting and DAFs
The Standard Deduction for 2021 is $12,550 for single filers, $18,800 for head of household filers, and $25,100 for joint filers. If you give to charity every year but typically take the standard deduction rather than itemize deductions, then those charitable gifts are not reducing your taxes.
It can be more tax efficient to consolidate your charitable giving for multiple years into one year. See the hypothetical scenario below for an illustration of the tax benefit. Consolidating gifting can be particularly useful during a high income year (sold a business, large bonus, etc).
Source: Schwab Charitable. “Four Ways to Maximize Charitable Giving Impact in 2021.” Accessed December 12, 2013. https://www.schwabcharitable.org/content/why-2021.
The idea of consolidating multiple years of giving into one may cause some hesitations for you as you may not know exactly who you want to give to and how much. Utilizing a donor-advised fund (DAF) is a great vehicle in this scenario.
A DAF functions as an account that holds contributions. In short, this allows you to receive the charitable deduction in the year created and gives you as much time as you need to decide which charities to give to.
Speak with a Family Legacy Planner
Ultimately, you want to be able to give to who you want to without worrying about the tax implications. Speak to a financial advisor who specializes in legacy planning to help you accomplish your gifting goals stress-free.