You may be surprised to hear that the gifts that you give to others are all taxable unless you are giving the gift to your spouse. The reason why you probably do not incur tax expenses when you give people birthday gifts is because of the fact that there is an annual gift tax exclusion.
Unified Federal Gift & Estate Tax
Before we get into the annual gift tax exclusion, we should explain the unified federal gift and estate tax from an overview. When you transfer assets to others, either while you are alive or after you pass away, transfer taxes are potentially applicable.
There is a $5.34 million unified lifetime exclusion in 2014. Anything that you transfer above this amount, while you are alive or after you pass away, is subject to the unified gift/estate tax if you do not take steps to mitigate your exposure.
The maximum rate of the federal gift tax and the federal estate tax sits at 40 percent at the present time.
Annual Gift Tax Exclusion
Now let’s get back to the annual gift tax exclusion. You do not start to utilize some of your unified lifetime exclusion as soon as you give anything to anyone in a given year. There is a $14,000 per year, per person gift tax exclusion.
You can give as much as $14,000 to any number of people within a given year free of the gift tax. These annual gifts do not impact the amount of your available unified gift/estate tax exclusion.
Because of this annual gift tax exclusion, lifetime gifting strategies can be useful when you are planning your estate as a person who is exposed to the estate tax.
$14,000 may sound like a very small amount of money on the surface. However, you have to remember that this is a per person exclusion. If you are married, you can combine your exclusion with that of your spouse to give as much as $28,000 to any number of individuals in a given tax year free of taxation.
Let’s say that you have a married son. You could give $28,000 to your son, and $28,000 to your daughter-in-law. That is a total of $56,000 transferred tax-free every year. If you were to do this for 20 years, you are looking at over $1 million in tax-free asset transfers.
If you have multiple children and grandchildren, using this strategy can indeed be quite effective depending on the specifics of your circumstances.
Tax-free gifts using the annual gift tax exclusion do not have to be confined to direct cash gifts. This exclusion can be used to incrementally fund certain types of irrevocable trusts or educational savings accounts. The exclusion can also be utilized to distribute shares in family limited partnerships in a tax-free manner.