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Estate Planning: 4 Common Mistakes When Using Gifting to Reduce Estate Taxes

Updated: Nov 4, 2023

How can you use gifting to your advantage?

Every year you can gift money to loved ones without it being subject to gift tax or counting against your lifetime gifting exemption amount. Your lifetime gifting exemption amount is 12.92 million per individual in 2023 which is separate from the annual amount you can gift tax free which is $17,000 in 2023.

This annual gift-tax exclusion amount can be used every year and each person can give to more than one individual. For example, a husband can give his two children, Jim and Sue, each $17,000 reducing his overall estate by $34,000. His wife can also gift Jim and Sue $17,000 each reducing the overall estate by $68,000. This amount will not be subject to gift tax or deducted from either spouses lifetime gifting exemption amount. Any amount gifted over the $17,000 to a single individual would be subject to gift tax and reduce the lifetime gifting exclusion amount.

Tips to Consider When Gifting

Tip #1: It is not advisable to gift a large asset that may have capital gains attached such as a home. In this instance, gifting it during your lifetime will transfer that taxable gain to the person receiving the asset. If you originally purchased the home for $100,000 but it is now valued at $400,000. The person you gifted the home to would be subject to $300,000 in capital gains tax. Instead, if this home was passed to your heirs at your death, this inheritance would receive a step up basis and any taxable gain they would owe would be eliminated. The moral is that inheritance is a much better gift!

Tip #2: You can take advantage of health care and education exclusions. You receive an unlimited exclusion for any payments made directly to a health care provider for qualified medical expenses or to an educational institution for tuition or to a 529 education account. To receive this exclusion, you cannot gift money to the individual to subsequently pay the health care provider or education institution as that would be considered a gift. It must be paid directly to the health care provider or educational institution.

4 Common Gifting Mistakes

Mistake #1 - Do not add a Joint Tenant on Real Estate

Adding someone to your real estate deed is considered a gift. This can lead to substantial consequences leading to both gift estate taxes and capital gains taxes. Instead, adding this asset to a revocable living trust for transfer after death is a technique that can save a considerable amount of money on both gift taxes and estate taxes. The person inheriting the property will be eligible for a step up basis which eliminates any capital gains tax and will not be subject to gift tax unless is is above the 12.92 million exemption amount. Capital gains tax will only apply to the appraised value of the property when inherited until the sale of the real estate. If the real estate is sold immediately after inheritance, there will be no capital gain tax assessed.

Mistake #2 - Do Not Add Your Child to Your Bank Account

A withdrawal above what the person contributed could result in a gift subject to gift estate taxes. Additionally, the joint holder has access to the entire balance of the bank account and can withdraw money at any time without your approval. Finally, your money could be at risk to your child's creditor claims as your child has an interest in your bank account money as your joint owner. Instead, place your bank account into a trust and add your child as the successor trustee if you are trying to accomplish the goal of allowing them to take over your finances should you be incapacitated or add them as the beneficiary of the trust or bank account if your goal is to transfer that asset to your child upon your death.

Mistake #3 - Do Not Pay Large Sums for a Wedding, Vacation, or Child's First Home

Parents and Grandparents often want to help with wedding expenses, contribute to the honeymoon, or assist with their child's first home purchase. The better option is gift up to the annual gift tax exclusion amount in multiple years. Amounts gifted over the $17,000 annual exclusion amount in a single year can be a reportable gift subject to gift taxes and will count against your lifetime gift exemption amount.

Mistake #4 - Canceling a Debt

Forgiving a loan is considered a gift in the amount that was forgiven. A better option is canceling up to the annual exclusion amount spread out over a few years.

Schedule a Family Wealth Planning Session to learn more by contacting Attorney Sarah Murillo at 623-282-4441.

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