Q. My wife and I worked very hard and many hours in our successful small business, and we were able to sell it for a tidy sum several years ago. We are now in our early 80s, and she has been encouraging me to agree to gift a very large sum of money to our children and grandchildren. She has read that time is running out to give more than $5 million without gift taxes or the need to file a return. We are very well off and would still have a lot of money if we were to reduce our net worth by $5 million, but I worry about unexpected emergencies such as unknown health issues that might arise for ourselves, children or one of our grandchildren. Being 82 and 83 may sound old to you, but we are in good health and may live many more years. My wife says I’m being foolish not to take advantage of this opportunity prior to the end of the year. Could we gift with the understanding that if we or another family member needs financial assistance, the others would gift to that person? What happens if we gift $5 million this year and the gift tax exclusion goes down next year? Do we owe taxes then? Does our estate get hit with more tax when we die?
A consultation with your estate planning attorney, tax adviser or both would be prudent. For those affluent enough to make large gifts without affecting their own current and future lifestyles, this is a good year to make gifts and take advantage of the lifetime gift tax limits in effect. Under current law, a person can gift assets up to $5.12 million out of an estate without paying gift or estate taxes. On Jan. 1, this dollar amount reverts to $1 million per person, and the maximum estate and gift tax rate will increase from 35 percent to 55 percent. Congress could extend the higher limits, but that is very doubtful. Your question concerning what happens if you gift and then the exclusion is reduced is referred to as the possible “gift tax clawback.” This is unlikely to occur; those that use the $5+ million exemption probably won’t lose anything if the exemption goes back down to $1 million. But there is no guarantee as to what Congress will do in future years.
Your wife is referring to the lifetime gift tax exemption, which is different from the annual gift tax exclusion. The annual gift tax exclusion is the amount that can be gifted by an individual to any number of people free from any federal gift tax or filing requirements. For 2012, this amount is $13,000, and for 2013, it is increased to $14,000. The lifetime gift tax exclusion is the amount above the annual exclusion that can be gifted by an individual over his or her lifetime to any number of people that will be free of gift taxes, but a gift tax return must be filed using IRS form 709. This amount reduces the amount that can be given away tax-free after death. In other words, this amount reduces your federal estate tax exemption. The federal estate tax exemption is currently equal to the gift tax exemption and is also scheduled to revert to $1 million in 2013. The federal estate tax also will increase from 35 percent to 55 percent.
If you gift up to $5.12 million this year, no tax is owed. If you wait until next year and the limit reverts to $1 million, you lose $4.12 million of exemption. The delay to next year will cost your heirs $2.266 million at the 55 percent tax rate. For married couples, these amounts double. Estate and gift planning before year’s end could be one of the best presents you could give your family.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 99466, Raleigh, NC 27624