Understanding the Basics of the Gift Tax

Many Long Island families think of the gift tax as something only the very wealthy need to worry about, and for the most part that is true. Still, understanding how it works can help you make smarter choices if you ever want to help a child, grandchild, or other loved one financially. Here is a plain language look at the basics.

Why a Gift Tax Exists

The federal government taxes large gifts of money or property mainly to support the estate tax system. Without a gift tax, a person could simply give away most of their property before passing away and avoid estate taxes entirely.

Because of this, the gift tax works as a kind of companion to the estate tax. That said, relatively few people ever end up owing gift tax during their lifetime, since there are built in allowances that let most everyday gifts pass tax free.

Common Reasons People Give

Gift giving often serves more than one purpose at once. Some gifts come from a wish to help a family member through a tough stretch, while others are part of a longer term financial or estate plan.

Reasons families commonly consider when building a gifting plan include:

• Helping someone who has an immediate financial need
• Giving a loved one a sense of financial security
• Letting a younger family member practice managing money
• Watching a recipient enjoy a gift while you are still around
• Making use of yearly tax exclusions
• Reducing the overall size of a taxable estate over time
• Passing along tax advantaged gifts to children or grandchildren

The Annual Gift Tax Exclusion

One of the simplest ways to reduce the size of a taxable estate over the years is to use the annual gift tax exclusion. This allows a person to give a certain amount each year to as many individuals as they choose without triggering any gift tax.

If a spouse agrees to split the gift on a gift tax return, a married couple can generally give a combined, larger amount to each recipient every year without owing gift tax.

These dollar limits are set by federal law and they do change from time to time, so it is important to confirm the current figures with a tax professional before relying on them for planning purposes.

Gifts for Medical and Education Expenses

Beyond the standard annual exclusion, there is a separate, unlimited exclusion available specifically for paying someone's medical or educational expenses.

The person receiving the benefit does not need to be related to you or claimed as a dependent, though many people use this option to help a grandchild with school costs.

The key requirement is that payment must go directly to the school, hospital, or other institution providing the service. If the money passes through the recipient's own hands first, it will not qualify for this special exclusion.

How a Gifting Plan Can Affect Your Estate

A single year of gift giving may not move the needle much on your overall estate tax picture. A consistent, multi year gifting plan, however, can meaningfully reduce the size of a taxable estate over time, since gifts made within the exclusion limits are generally protected from federal estate tax.

There is another benefit worth noting. When you give away an asset, any future growth in that asset's value moves out of your estate along with it.

For example, imagine giving stock currently worth a certain amount to your children today. If that stock grows substantially in value over the following years, that growth will not be counted as part of your estate when you pass away, because the asset itself already belongs to someone else.

This is general information and not tax, legal, or financial advice. Gift and estate tax rules can be detailed and limits change periodically, so individual circumstances should always be reviewed with a qualified tax advisor or attorney.

This article is general information, not legal, tax or financial advice. Coverage depends on the terms, conditions and exclusions of each policy. Talk with a licensed agent about your situation.