Tax Free Gifting

You may be aware that the federal estate tax, which was repealed for 2010, resumes in 2011 on estates with assets exceeding $1 million dollars. The Massachusetts estate tax remains in effect and also taxes estate assets over $1 million. In addition to worrying about estate taxes, the law also requires you to pay a gift tax, currently at 35%, if you gift more than $1 million during your lifetime. However, there are several simple, low cost strategies you can use now to transfer your wealth to family members without incurring significant legal fees or taxes.

1. The IRS permits you to give $13,000 in cash or other assets per year to each of as many individuals as you want without having to worry about the gift tax. Spouses can combine this annual exclusion to jointly give $26,000 to each of as many people as they like, tax-free. For example, a couple with an adult child who is married and has two children could make a joint cash gift of $26,000 to the adult child, the child’s spouse and each grandchild—four people—providing the family with $104,000 a year. If some of the recipients are minors, their portion of the gift may have to go into a custodial account that designates an adult to oversee the money, generally until the child reaches age 21. Be aware that if you name yourself as the custodian, the funds could be considered part of your estate. Instead, you should name the child’s parent, or some other person, who can use the money to purchase items or services for the child.

2. You can invest money in Section 529 education savings plans for your children, grandchildren or other relatives. Establishing these plans for relatives could relieve your children or grandchildren of the need to save for college at a time when they may be overwhelmed with current expenses. You can set up a separate account for each family member you want to benefit. Although your contributions to a 529 account are considered gifts, there are two unusual benefits: money in these accounts grows tax-free and it can be withdrawn tax-free, provided it is used to pay for college, a graduate, vocational or another accredited school, or for related expenses.

3. The IRS also permits lump-sum deposits of as much as $65,000 to a person at once ($130,000 for married couples), as long as you file a gift-tax return that treats the gift as if it had been spread over five years. However, if you die before the five years is up, the part of the gift that reflects the number of years remaining will be considered part of your estate. Also, if you need the money yourself, any earnings that are withdrawn are subject to income tax and a 10% penalty.

4. Without using your annual $13,000 exclusion, you can pay for tuition, dental and medical expenses of anyone you want as long as you make the payments directly to the providers of those services. This is an effective way to help family members with increasing tuition costs, whether for preschool, private school or college or even health care expenses, including health insurance premiums, orthodontia, medically necessary home improvements or home-care attendants.

5. You can lend money to family members at favorable rates as long as you formalize the loan. If you lend money to family members, for example to buy a house or a car or start a business, you have to charge a minimum rate of interest set each month by the Treasury, called the Applicable Federal Rate, to avoid potential gift tax and income tax consequences. Recently, the rate for long-term loans (those lasting more than nine years) and requiring monthly payments has been an extremely attractive rate between 4 and 5%. That’s less than your family members would have to pay for a bank loan, assuming they could get one in today’s tight credit market, but more than you could earn from CDs or money market accounts.

Gifting now when you are alive may leave less for inheritance, but you receive the immediate benefit of reducing your taxable estate while giving money to the people you love when they need it most.

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