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Tax Efficient Methods of Gifting

By: Investor Solutions

By: Investor Solutions

Have you ever found yourself in a situation where you wanted to help a family member or dear friend fulfill a dream? A dream that required financing? Many financially secure adults find themselves in this very situation. Unfortunately, some of them are unaware of the different methods of gifting to family, friends and strangers alike while avoiding the gift tax.

First, let’s talk briefly about the gift tax. An individual can gift up to $1 million during their lifetime free of gift tax. This $1 million translates into an applicable credit amount of $345,800. For donors who gift in excess of $11,000 to any donee in one calendar year, the gift must be reported on Form 709. The gift tax liability is determined by applying the applicable tax rate to the total amount of taxable gifts made by the donor during the calendar year. Taxable gifts are the total gifts made by the donor reduced by the annual exclusion per donee. Gift taxes are based on a progressive rate schedule capped at 48%.

Let’s move on now to discuss the various methods of gifting without paying tax on the transfers.

Annual gift exclusion

Perhaps the most direct way of gifting is through gifts of annual exclusion. An individual can make a gift of $11,000 (increased from $10,000 in 2001) of cash or property per recipient per year. If you choose to gift split with your spouse, the amount of the annual gift is increased to $22,000. The gift must be of a present interest meaning that the recipient of the gift can use the money immediately and without restriction. Gifts of future interest (i.e., reversions, remainders and the like) do not apply for the exclusion. One issue to consider when making gifts of present interest is whether you are willing to relinquish control of those funds. It may be difficult to watch your college age grandson squander your hard earned money on the fastest hot rod rather than spending it on paying for a college education. Situations such as this happen all too often but they can be prevented.

Section 529 Plans

Although it is too late to set up a 529 for your college age grandson, it’s not too late to set one up for his little sister who is still in grade school. Simply stated, Section 529 plans are tax-advantaged vehicles that allow single parents, grandparents or other individuals to contribute money to an educational savings plan. Contributors may want to contribute the amount of the annual exclusion to such a plan for a number of years. It is also possible to front load contributions to this plan. That is, an individual can contribute $55,000 in the first year of a five-year period. However, five years must lapse (remember $11,000 per year) before that person can make an additional gift to that plan. Again, if the contributor is a married person, that amount increases to $110,000. Even though contributions to a 529 plan are considered completed gifts, the individual who established the account (owner) still maintains control of the assets.

Gifts of education or medical expenses

Let’s go back to your grandson who is on the threshold of college life. Unfortunately, you don’t think he is mature enough to spend an $11,000 cash gift in a manner that meets with your approval. If this is the case, don’t despair, you can still give him the gift of education. In addition to the annual exclusion, an unlimited gift tax exclusion is allowed for amounts paid on behalf of a donee as long as it is made directly to the educational institution. The unlimited exclusion applies to tuition only, however. Expenses for books, supplies and on campus living are excluded.

The same concept applies to medical expenses. As long as you pay the person providing the qualifying medical care directly, you will avoid having to pay the gift tax. Qualifying expenses include diagnosis and treatment of a disease, transportation for medical care and medical insurance.

Both the medical and education tuition exclusions are available to donors without regard to their relationship with the donee.

Gifts to a spouse

Gifts to a U.S. citizen spouse are also unlimited and avoid the gift tax. Gifts to foreign spouse are limited to $117,000 for 2005 provided that the transfer would qualify for the marital deduction if the spouse were a U.S. citizen.

Gifts to charitable and political organizations

Gifts to charitable or 501(c)(3) organizations are unlimited. These are nonprofit entities that have received tax-exempt status under the aforementioned tax code. Gifts made to these organizations are gift tax free as well as income and estate tax deductible.

Gifts to political organizations are also unlimited and gift tax free. However, unlike charitable gifts, they are not income deductible. They are estate tax deductible if they are made to a political subdivision of the government, and if the political organization is not an organization that benefits a private individual or his political campaign or attempts to influence legislation.

These are some of the more common and easiest methods of gifting. There are issues to consider when gifting, however. These encompass not only financial concerns but emotional ones as well. And if you are ever in a quandary about whether or not to gift, remember, it is better to give than to receive.