One of the most common questions we receive from parents of any age (but especially over 65) is how much the person or couple is able to gift. Clients often make this answer easier by following it up by asking if they are able to gift ten, eleven, twelve, or thirteen thousand dollars each year to a particular child.
These questions relate to a commonly misunderstood gifting concept. To simplify things, it is important to understand that gifts are subject to federal gift tax. This gift tax is paid by the giver of the gift.
However, in 2014, each person effectively has a $5 million lifetime gift tax exemption (which, indexed for inflation, is actually $5.34 million). This is the amount that a person can give away during his or her life without paying federal gift tax. Once gifts are given that "eat into" this exemption, it is permanently reduced by the amount of those gifts.
A person is able to give away $14,000 per person in 2014 without reducing (or "eating into") this lifetime gift tax exemption. If the giver of the gift is married (or is gifting to a married person), this gift amount may be "split" between spouses, allowing for a gift of $28,000 per person, per year.
You may be thinking that this gift tax exemption amount sounds eerily similar to the better-known federal estate tax exemption of $5 million (or $5.34 million). The lifetime gift tax exemption mentioned above is also known as the "Unified Credit" because the lifetime gift tax exemption and the federal estate tax exemption are linked. If you are confused, here is a simple example that may clear things up:
Paul is an 85 year old widower of considerable wealth. In 2014, he gives away $2 million to his son and $2 million to his daughter, for a total of $4 million in gifts that year. Now, he has used up $4 million of his federal gift tax exemption. This has reduced his federal estate tax exemption by an equivalent amount. If he dies in 2015 and the federal estate tax exemption is still $5.34 million per person, then only $1.34 million of his estate will be exempt from federal estate tax. This is because his exemption of $5.34 million was reduced by $4 million dollars in gifts.
In reality, the calculations are somewhat more complex than above, but the example should illustrate the unified credit approach that has been taken in taxing gifts and estates. The American Taxpayer Relief Act of 2012 made some important changes to how these exemptions work.
If you read the above and thought "Well why should I care about that $14,000 annual exclusion amount if I don't have millions of dollars?" then you are correct. There is little need for most Americans to be concerned about annual exclusion gifts today, since the above federal exemption levels are so high, and because they are permanent (or, as permanent as any tax rates can be).
For most people, better questions about gifting are as follows:
(1) Am I sure I won't need those assets later?
(2) What is the effect of gifting on my ability to receive Medicaid?