Gift taxes, which were first imposed by the Revenue Act of 1924, are imposed when there is a voluntary transfer (i.e., gift) of cash or other property from one individual to another for less than fair market value.
Fair market value is defined by the Internal Revenue Service (IRS) as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
Each individual is allowed to donate up to $13,000 in cash or property per donor per year without being taxed, a practice known as the annual exclusion.
To ensure that your gift-giving is efficient, consult a tax professional such as an estate planning lawyer, a CPA, or an EA. They can keep you up to date on estate planning laws, point out tax loopholes, and dispel common myths.
Many people are unaware that the annual exclusion amount is indexed for inflation (it usually increases $1,000 every few years), that it applies to both husband and wife, or that a gift tax credit allows an individual to make lifetime gifts totaling one million dollars without incurring gift tax.
Furthermore, certain gifts are exempt from taxation, such as property transfers in a divorce settlement, donations to a provider of educational or medical services, and outright gift refusals. Others, such as gifts from a donor to a spouse and accredited charitable contributions, are fully deductible from transfer taxes.
It is critical to understand the legal and financial implications of gift taxes because you could end up costing yourself, your estate, and your beneficiaries thousands of dollars if you unintentionally shortchange your gift or your estate is audited and penalties for insufficient tax payments are assessed. Furthermore, making gifts reduces the size of your taxable estate before your death.
According to Ed Robinson, an attorney and member of the Estate Planning Department at Hurwitz & Fine, P.C. in Buffalo, N.Y., life insurance can be used to avoid paying unnecessary gift taxes.
“A common way to deal with the estate tax is to have a life insurance policy that is owned by a third party – an irrevocable trust,” said Robinson. “The death benefit will not be included in my estate upon my death because the trust owns the policy, and it won’t be paying any estate taxes. Death benefits aren’t considered income, so no income taxes will be paid on it. The beneficiaries of the life insurance policy would receive those benefits without estate tax or income tax. It’s a nice, tax-free plan to benefit my beneficiaries.”