When you hear about the existence of the federal gift tax, you may wonder if it is possible to give tax-free gifts to your children. The answer is yes and no.
A Look at the Gift Tax
The gift tax exists to close a loophole. The estate tax was first implemented in 1916. Originally, there was no gift tax to go along with it. As a result, people who were exposed to the estate tax gave away assets while they were living to avoid the death tax.
As a response, the gift tax was implemented a few years later. After a brief repeal it returned, and it has been in place ever since.
When you give gifts to your children they are taxable, but there are credits or exclusions. The only relative that you have that is completely exempt from the gift tax is your spouse. You can give unlimited gifts to your spouse free of transfer taxes.
Unified Gift and Estate Tax Exclusion
The gift tax and the estate tax are unified, and there is a unified credit or exclusion. The amount of this exclusion in 2014 is $5.34 million.
You could arrange for a total of as much as $5.34 million to be transferred tax-free, whether the transfers take place while you are living or after you pass away. This is why most people don’t have to worry about transfer taxes.
Annual Gift Tax Exclusion
In addition to the unified lifetime gift and estate tax exclusion, there is an annual gift tax exclusion. This exclusion allows each taxpayer to give as much as $14,000 to any number of individual gift recipients within a calendar year free of the gift tax.
To be absolutely clear, gifts that you give using this annual gift tax exclusion would not reduce the amount of your available unified gift and estate tax exclusion. You would only be using a portion of your unified lifetime exclusion if you gave a tax-free gift to someone within a calendar year that exceeded $14,000 in value.
Getting back to the question of whether or not you can give tax-free gifts to your children, you could certainly do this using the annual gift tax exclusion, even if you are ultimately going to be exposed to the estate tax.
Utilization of this annual gift tax exclusion is something that is commonly done by those who are looking for tax efficiency. You can use the annual exclusion to give gifts over an extended period of time in a tax-free manner.
When you do this you are getting money into the hands of those who would otherwise be inheriting it tax-free. As you do so, you are reducing the value of your estate, and this has positive long-term tax consequences.