In Clark Kendall’s book, Middle-Class Millionaire: Surprisingly Simple Strategies to Grow and Enjoy Your Wealth, chapter 18 explains “Planned Giving” and walks through best practices of gifting. Below is a story about Rich and Barbara and real-life examples of how to gift efficiently.
Rich is a retired film stuntman who, after a long career, is enjoying his retirement. Some of what he’s enjoying about his retirement is sharing part of his accumulated wealth with his family, specifically his wife and two sons. Like many Americans, Rich likes to make sure that, when he’s sharing that wealth, he isn’t giving the I.R.S. more than necessary.
Rich knows about the gift tax and knows how to make those gifts without running headlong into a taxable situation. This is Rich’s responsibility because the I.R.S. puts the onus on the giver. If the gift is a taxable event and Rich doesn’t pay up, then the responsibility falls to the beneficiaries after he passes in the form of estate taxes. These rules are in place so that Rich can’t simply give his entire fortune to his sons before he dies without some of it being taxed as income or capital gains.
Exemptions for family and friends. It would be different for Rich’s wife, Barbara. The unlimited marital deduction means that gifts that Rich gives to Barbara (or vice versa) never incur the gift tax. There’s one exception, though. If Barbara is a non-U.S. citizen, there’s a limit to what Rich can give to her, up to $155,000 per year. (This is the limit for 2019; it’s attached to inflation.)
The gift limit for other people, whether family or not, is $15,000 and it applies to both cash and noncash gifts. So, if Rich buys his older son Jack a $15,000 motorcycle, it’s the same as writing him a $15,000 but of course harder for the IRS to track. Spouses have their own separate gift limit so Barbara could also write Jack a $15,000 check from the account she shares with Rich. So long as each gift is less than $15,000 annual there is no problem.
Education and healthcare. The gift tax doesn’t apply to funds for education or healthcare. So, if Jack breaks his leg riding that motorcycle, Rich can write a check to the hospital. If his other son David goes back to college to become a lawyer, Rich can write a tuition check to the college. This only works if Rich is writing the check to the institution directly; if he’s writing the check to the beneficiaries (i.e. Jack and David), he might incur the gift tax.
The Lifetime Gift Tax Exemption. What if Rich were to go over the limit? The lifetime gift tax exemption would go into effect, and the rest would be reported as part of the lifetime exemption via Form 709 come next April. Unlike the annual exemption, the lifetime exemption is cumulative for Rich. Currently, that lifetime exemption is $11.4 million.
Being a stuntman and an active extreme sportsman, Rich is concerned about his estate strategy. If he were to borrow Jack’s motorcycle and attempt to jump the Snake River Canyon, what would happen if he didn’t make it across? If that unfortunate event occurred in 2019, and he gave $9 million over his lifetime, and his estate and all of that giving totaled more than $2.4 million, the estate may owe a federal tax and possibly a state estate tax. Barbara would have her own $11.4 million lifetime exemption, however, and since she is the spouse, estate taxes may not apply.
It should be noted that in Maryland, where Kendall Capital is based, the state decoupled from the federal government and as of 2019 imposes a state of Maryland estate tax starting at 16% of the assets above $5 million. This on top of the federal estate taxes which begins for estate worth more than $11.4 million. We are finding that many financially successful individuals and families are strategically moving to states that do not have estate taxes. For example, a wealthy individual with a $15 million estate will pay approximately $1.6 million less in estate taxes living in McLean, VA versus Potomac, MD.
Navigating the tax rules that govern charitable donations along with gifts to non-charities, such as your family members, and using all the forms of giving to your best advantage is fairly complex. However, with guidance from a financial professional at Kendall Capital, you can help your charitable dollars do even more good.