Techniques to Reduce or Avoid Federal Gift Tax

Giving a gift does not always have to result in the donor incurring gift taxes. Certain tax laws and techniques exist that make it possible for gift givers to reduce what they will owe, or even avoid paying the gift tax altogether. Often the key is understanding and utilizing one of these techniques before the gift is made.

The threshold factor to note is that the fair market value of the gift determines whether someone will even incur gift taxes. Under current law, gifts below a certain amount are exempt from taxation, so some donors will be completely exempt from the gift tax based on the gift’s fair market value. From time to time, the Internal Revenue Service (IRS) adjusts this exemption limit, so be sure to check for changes in the law each year before making gifts. For 2019, the annual exclusion is $15,000 per person, or $30,000 for married couples (the same as in 2018 and increased from $14,000 for 2017). If you exceed these limits, you could wind up owing a gift tax.

Keeping gifts under the exemption amount is made easier by the fact that there is no limit to how many people you can make a gift to in a taxable year. For example, say Anne has 10 grandchildren and an estate valued at $1 million. Rather than giving a large sum to a different grandchild each year, she can avoid the gift tax completely if she gifts $15,000 to each of her 10 grandchildren each year. Anne can continue to give this way each year until her funds are exhausted without incurring any gift tax or estate tax. Under federal tax law, an individual taxpayer can gift up to $11.4 million tax-free during his or her lifetime (this lifetime exclusion– which adjusts periodically for inflation– was doubled by the Tax Cuts and Jobs Act of 2017; however, the exclusion amount is scheduled to expire and revert to 2017 exemption amounts at the end of 2025).

Give a Loan, Get Out of Gift Taxes

Another popular way to avoid the gift tax is by making a loan to family members, charging them an interest rate lower than the rate offered through a commercial bank. Clearly document that the money given is a loan at a set interest rate. In fact, structuring a loan to avoid gift tax can be complicated and tricky, so consulting an experienced estate planning attorney or accountant might be a good idea to avoid any unpleasant tax consequences. A professional can draw up the proper documentation should the IRS require you to provide proof that the loan is valid.

529 College Plan Contributions

Putting money into a Sec. 529 college savings plan is another way to make a large gift while incurring the gift tax. Single taxpayers can gift up to $70,000 to a beneficiary’s college savings plan and married taxpayers can contribute up to $140,000. However, if the contribution to a college savings plan exceeds the annual gift exemption limit, the amount will be spread out over five years instead of all in one year and no other gifts can be made to that individual tax-free. For example, assume Joe contributes the maximum of $75,000 to his grandson’s college savings plan. The $75,000 contribution will be considered to be a series of $15,000 gifts made over a period of 5 years. Joe could continue to give gifts to his grandson, but any further gifts will not be tax-free since he has reached that limit for gifting to his grandson. However, Joe could continue to give to other family members up to the $15,000 limit.

Tuition or Medical Expense Payments Offer Even Greater Gift Tax Savings

Paying tuition or medical expenses for family members is another way to make a larger, tax-free gift. While there is no limit on how much a taxpayer can pay for tuition or medical expenses, the expenses must be paid by the taxpayer directly to the educational institution or health care provider. Let’s assume Joe’s granddaughter is a freshman in college with a tuition bill of $25,000 per year. While that amount is far above the annual gift exemption limit, as long as Joe pays his granddaughter’s tuition by making the payment directly to the college, this will be considered a tax-free gift in its entirety.

While there are a number of ways to avoid paying the gift tax, consulting an experienced estate planning or wills and trusts lawyer is always advisable in making sure that you are following the proper procedures and maintaining the necessary records for the IRS. When it comes to reducing or avoiding gift taxes, the proper documentation is an absolute must in substantiating the legal nature of your gifts.

Case Studies: Techniques to Reduce or Avoid Federal Gift Tax

Case Study 1: Leveraging Annual Exclusion Limit

Anne, with an estate valued at $1 million, has 10 grandchildren. To minimize gift tax, Anne chooses to gift $15,000 to each grandchild annually. By staying within the annual exclusion limit, Anne avoids gift tax while ensuring a tax-free transfer of wealth to her grandchildren.

Case Study 2: Structuring Loans as Gifts

John wishes to provide financial assistance to his family members without incurring gift tax. He offers them loans with an interest rate lower than commercial rates. To avoid tax complications, John diligently documents the loans as valid and consults estate planning experts to ensure compliance with the IRS regulations.

Case Study 3: Utilizing 529 College Savings Plans

Susan plans to contribute significantly to her granddaughter’s college fund. By utilizing a 529 college savings plan, she can contribute up to $70,000 (or $140,000 for married couples) without incurring gift tax. The contribution, if exceeding the annual exemption limit, can be spread out over five years to avoid gift tax implications.

Case Study 4: Paying Tuition and Medical Expenses

George aims to support his family members by covering their tuition and medical expenses. By making direct payments to educational institutions and healthcare providers, George can provide financial assistance tax-free, as these expenses are exempt from the gift tax.