Introduction
Gifting money or other items of value to family members and friends can be a meaningful gesture that shows your appreciation and love for them. But it can also come with an unexpected tax bill if you’re not careful. That’s because gifts are subject to the federal gift tax, which is imposed on those who give away more than a certain amount of money or assets during their lifetime.
The good news is there are ways to avoid the gift tax. In this article, we’ll explore 8 strategies you can use to keep your gifts from being subject to the gift tax.
Give Gifts Within the Annual Gift Tax Exclusion Limit
One of the easiest ways to avoid the gift tax is to give gifts within the annual gift tax exclusion limit. Under the Internal Revenue Code, the annual exclusion limit is currently $15,000 per recipient, per year. This means that you can give up to $15,000 to as many people as you want without having to pay any gift tax.
It’s important to note that the annual exclusion limit does not apply to gifts made to a spouse who is a U.S. citizen. For those gifts, you can take advantage of the unlimited marital deduction, which we’ll discuss in more detail later.
How to Calculate the Amount of a Gift
When calculating the amount of a gift for the purpose of determining whether or not it falls within the annual exclusion limit, you must include the fair market value of the gift. Fair market value is the price at which the gift would sell for in an open market between a willing buyer and a willing seller.
For example, if you gave your niece a piece of jewelry worth $20,000, the amount of the gift would be $20,000, not the amount you paid for it. The same goes for gifts of real estate, stocks, and other assets—the amount of the gift is based on the asset’s current fair market value.
Make Charitable Donations in Lieu of Giving Gifts
If you want to give a large sum of money to someone but don’t want to pay the gift tax, consider making a charitable donation in lieu of giving a gift. Donations to qualified charities are generally deductible on your taxes, which means you won’t have to pay any gift tax.
In order to qualify for a charitable deduction, the donation must be made to a qualified 501(c)(3) organization. Donations to individuals, even if they are in need, do not qualify for a charitable deduction.
It’s also important to note that donations must be made before December 31st of the year in which you want to take the deduction. If you make the donation after that date, you will have to wait until the following year to take the deduction.
Benefits of Making a Charitable Donation
Making a charitable donation in lieu of giving a gift has several benefits. Not only does it allow you to avoid the gift tax, but it also gives you the added benefit of a tax deduction. Depending on your tax bracket, this could result in a substantial savings on your taxes.
Additionally, making a charitable donation is a great way to give back to your community. It’s a selfless act that can help those in need while also providing you with a financial benefit.
Set Up a Trust or Other Legal Entity to Manage and Distribute Funds
Another way to avoid the gift tax is to set up a trust or other legal entity to manage and distribute your funds. A trust is a legally binding agreement between a grantor (the person creating the trust) and a trustee (the person responsible for managing the trust).
Trusts can be used to manage and distribute funds to beneficiaries in a variety of ways, such as providing for the care of minor children or providing income for elderly parents. They can also be used to give gifts to family members without triggering the gift tax. This is because gifts made to trusts are not considered taxable gifts.
Benefits of Setting Up a Trust
Setting up a trust has several advantages. One of the biggest advantages is that it allows you to control how and when funds are distributed to beneficiaries. This is especially helpful if you have minor children and want to ensure that their inheritance is managed responsibly.
Additionally, trusts can provide tax savings. Any income earned by the trust is taxed at the trust’s rate, which is typically lower than the personal income tax rate. This can result in significant tax savings for the grantor and beneficiaries.
Utilize the Unlimited Marital Deduction
If you’re married and want to give a large sum of money to your spouse, you can do so without having to pay any gift tax. This is because of the unlimited marital deduction, which allows married couples to give each other an unlimited amount of money without incurring any gift tax liability.
It’s important to note that the unlimited marital deduction only applies to spouses who are U.S. citizens. If your spouse is a non-U.S. citizen, you can still give them a gift, but you will have to pay gift tax on any amount over the annual exclusion limit.
Take Advantage of the Educational and Medical Exclusion
If you want to give money to someone for educational or medical expenses, you can do so without having to pay any gift tax. This is because of the educational and medical exclusion, which allows you to give up to $15,000 per person, per year for qualifying expenses without incurring any gift tax liability.
Qualifying expenses include tuition, fees, books, supplies, room and board, and medical expenses. However, it’s important to note that the money must be given directly to the educational institution or medical provider. Gifts of cash to the recipient do not qualify for the exclusion.
Use 529 Plans to Save for College Tuition Costs
A 529 plan is a tax-advantaged savings plan designed to help families save for college tuition costs. Contributions to a 529 plan are not subject to the gift tax, which makes it an attractive option for those looking to avoid the gift tax while saving for college.
Additionally, withdrawals from a 529 plan are not subject to federal taxes as long as the money is used for qualified higher education expenses. This makes it a great way to save for college tuition costs without having to worry about the gift tax.
Pay Directly for Someone Else’s Tuition, Medical Expenses, or Other Qualifying Expenses
You can also avoid the gift tax by paying directly for someone else’s tuition, medical expenses, or other qualifying expenses. As long as the payment is made directly to the educational institution or medical provider, it is not considered a taxable gift.
For example, if you want to pay for your nephew’s college tuition, you can do so without having to pay any gift tax as long as you make the payment directly to the school. Similarly, if you want to pay for your sister’s medical bills, you can do so without having to pay any gift tax as long as you make the payment directly to the doctor or hospital.
Conclusion
Gifting money or other items of value can be a great way to show your appreciation and love for someone, but it can also come with an unexpected tax bill. Fortunately, there are ways to avoid the gift tax. By following the strategies outlined above, such as giving within the annual exclusion limit, making charitable donations, setting up a trust, utilizing the unlimited marital deduction, taking advantage of the educational and medical exclusion, using 529 plans to save for college tuition costs, and paying directly for someone else’s expenses, you can give generously without having to worry about the gift tax.
