Family Wealth Preservation 101: Take Advantage of Gift Tax Exclusion
So you worked hard and finally made it and along the way paid your taxes. Now you want to gift your hard earned money to your children and grandchildren, thinking that since you have already paid your taxes there should not be any more taxes on your wealth, right? Wrong! I introduce to you Estate Tax, also known as the Death Tax!
Once you pass away and transfer your money to your heirs, the Death Tax kicks in. If your total assets are above the threshold ($11,400,000 for 2019) you must pay the Death Tax before transferring any money to your heirs, which is roughly 40%. Now what can you do to avoid paying the death tax, and gift tax for that matter.
First, you must start giving gift every year to your children and grandchildren. The gift exclusion amount in 2019 is $15,000 per "donee", meaning that you can give up to $15,000 per person each year without paying any gift tax on it. You do not even have to report this gift. This is the famous Gift Tax Exclusion. For example, if you have a married daughter who has two children, you can give $15,000 gift each year to your daughter, her husband, and your two grandchildren. So overall you have paid $60,000 gift to your next generation without incurring any gift tax. If you are married yourself, your spouse can make the same gifts. So between you and your spouse, you can gift $120,000 each year to your daughter, her husband and your grandchildren without paying any gift tax.
Now what happens if you gift more than $15,000 per person. Any amount over the $15,000 will reduce your "Unified Credit" which as it was mentioned earlier it is $11,400,000 for 2019. Keep in mind that the Unified Credit can change depending on which party has the majority in the congress (before Trump's tax reform, the unified credit was $5,490,000). Once you use your entire UC, you will start paying 40% on the gifts that you make. So you start giving the $15,000 annual gift to your children and grandchildren early, so you can save your UC which will come very handy in future for your Estate Tax planning.
Also instead of cash, let's say you have a appreciated assets. If you sell the asset yourself and pay cash gift to your grandchildren, first you will have to pay tax on the gain on the sale of your asset, and then give the gift. But if your grandchildren are in lower tax bracket (since they do not have any source of income yet (depending on their age)) it is beneficial to gift the asset directly to them. This they will pay less tax or even no tax on the assets. Let's say you have a stock that you bought years ago for $15,000, and now it is worth $50,000. If you sell the stock you will have to pay about 20% tax on the $35,000 gain ($7000) and then you can give $15,000 gift to your grandchild. But instead, you can gift the stock to your grandchild free of gift tax and also you won't need to pay any tax on the gain of the stock (you save another $7,000) and once your grandchild sell the stock, she will have to pay tax on the $35,000 gain, which if she has no other income in 2019, she will pay $0 in tax (not bad, right?)
Once you pass away and transfer your money to your heirs, the Death Tax kicks in. If your total assets are above the threshold ($11,400,000 for 2019) you must pay the Death Tax before transferring any money to your heirs, which is roughly 40%. Now what can you do to avoid paying the death tax, and gift tax for that matter.
First, you must start giving gift every year to your children and grandchildren. The gift exclusion amount in 2019 is $15,000 per "donee", meaning that you can give up to $15,000 per person each year without paying any gift tax on it. You do not even have to report this gift. This is the famous Gift Tax Exclusion. For example, if you have a married daughter who has two children, you can give $15,000 gift each year to your daughter, her husband, and your two grandchildren. So overall you have paid $60,000 gift to your next generation without incurring any gift tax. If you are married yourself, your spouse can make the same gifts. So between you and your spouse, you can gift $120,000 each year to your daughter, her husband and your grandchildren without paying any gift tax.
Now what happens if you gift more than $15,000 per person. Any amount over the $15,000 will reduce your "Unified Credit" which as it was mentioned earlier it is $11,400,000 for 2019. Keep in mind that the Unified Credit can change depending on which party has the majority in the congress (before Trump's tax reform, the unified credit was $5,490,000). Once you use your entire UC, you will start paying 40% on the gifts that you make. So you start giving the $15,000 annual gift to your children and grandchildren early, so you can save your UC which will come very handy in future for your Estate Tax planning.
Also instead of cash, let's say you have a appreciated assets. If you sell the asset yourself and pay cash gift to your grandchildren, first you will have to pay tax on the gain on the sale of your asset, and then give the gift. But if your grandchildren are in lower tax bracket (since they do not have any source of income yet (depending on their age)) it is beneficial to gift the asset directly to them. This they will pay less tax or even no tax on the assets. Let's say you have a stock that you bought years ago for $15,000, and now it is worth $50,000. If you sell the stock you will have to pay about 20% tax on the $35,000 gain ($7000) and then you can give $15,000 gift to your grandchild. But instead, you can gift the stock to your grandchild free of gift tax and also you won't need to pay any tax on the gain of the stock (you save another $7,000) and once your grandchild sell the stock, she will have to pay tax on the $35,000 gain, which if she has no other income in 2019, she will pay $0 in tax (not bad, right?)
Plan Ahead
Annual gift tax is one of many ways you can preserve the wealth in your family. For a more comprehensive Family Wealth Preservation planning please contact us.