Oftentimes, the complexity of developing and accumulating wealth includes not only how to handle and manage it, but even how to properly give some of it away. It can be complicated enough to try and understand the moving parts of your financial plan, let alone figure out estate planning aspects with gifting and how to properly go about it.
General Rules
Typically, the IRS will allow a tax-free gift of $16,000 to be made per donor to a donee annually.
This sounds extremely restrictive, but maybe an example will shed some light here. Let’s assume that Uncle Sam and Aunt Martha have significant assets and that they would like to give some to a nephew and his wife.
In terms of gifting, the husband and wife can each gift $16,000 in order to both remain tax-free. In this case, Uncle Sam gives $16,000 to his nephew Joe and another $16,000 to Joe’s wife, Anna. Aunt Martha can also give $16,000 to Joe and another $16,000 to Anna.
In total, $64,000 could pass tax-free as gifts to Joe and Anna if performed correctly.
There is a form to fill out to record gifts because the IRS tracks these transactions, and spouses that gift together in this manner need to highlight on the IRS form that they are gifting separately from each other. If not specified on the tax form, you could accidentally end up with an unanticipated gift tax bill.
You can choose to give over $16,000 per donor to an individual donee, but you must recognize and understand that anything over $16,000 is taxable in that year. Though the IRS does allow these $16,000 gifts during your lifetime that are tax-free, overall, there are no free lunches—the amount you give over the annual tax-free limit during your lifetime is subtracted from your estate exclusion amount at death.
The estate exclusion amount is a certain dollar amount of an estate that can pass tax-free to heirs without paying estate tax. The current estate tax exclusion amount is $12.06 million. Anything gifted over the tax-free annual limit during life reduces the estate tax exclusion amount that will apply to your estate.
Unlimited Marital Deduction
Unlimited marital deduction is an estate planning tool to assist in wealth transfers.
Essentially, a spouse can pass all of his/her assets to their spouse tax-free. The key here is that taxes are not being avoided but deferred to the future.
This is only useful when a spouse dies and leaves his estate to their surviving spouse — it does not apply to any other relationships. The surviving spouse may need an income stream for the rest of their lifetime, and the unlimited marital deduction allows a large dollar amount of assets to pass to the surviving spouse in order to provide for their needs before taxes are paid at the death of the surviving spouse.
Although there are specific rules and restrictions as to how to use the unlimited marital deduction, there are also a few exceptions to those rules. It is always wise to consult with your advisor to map out the appropriate estate planning tools to use in your specific situation.
DAF (Donor-Advised Funds)
Donor-advised funds are a unique tool that allows an individual to get an income tax deduction today and to give to the charity “tomorrow,” so to speak.
To explain in greater detail, the IRS recognizes a contribution of assets to a DAF in a given year as a charitable deduction because the money will eventually go to a charity, and a contribution to a DAF is considered an irrevocable gift. The purpose of a DAF is to contribute dollars that qualify for a tax deduction today to an account that is saved and invested to be given to the charity at a later date.
The benefit derived is primarily at a future point in time.
For example, let’s say that Uncle Sam and Aunt Martha typically earn $100,000 in income per year and plan to give $10,000 annually for the remainder of their lives.
For the first 10 years, let’s assume that they continue to give by cash or check as usual, but they also fund their DAF with $10,000 annually. At the end of the 10 years, they would expect to have around $141,470 in the account, assuming a 7.5% rate of return on the invested assets.
Ten years later, Sam and Martha can discontinue charitable contributions from their own earned income and now use the DAF account to gift annually. Ideally, the DAF account would get to a self-sustaining stage where annual withdrawals do not diminish the core account value, much like how a retirement portfolio designed for lifetime income would be treated.
If allowed time to build and accumulate, this can be an excellent tool for people with charitable giving desires.
Qualified Charitable Distributions
Many retirees, upon reaching age 72, discover that their traditional IRA or rollover IRA requires a “minimum distribution” each year from their account.
This distribution is calculated according to IRS tables based on the size of the account multiplied by a factor rating based on your life expectancy.
For example, an account worth $1,000,000 may be multiplied by a factor rating of 1/26, which equates to a “required minimum distribution” of $38,461.54. Some retirees already have sufficient income each month in the form of social security, pension plans, annuities, real estate rentals, etc. They have no need for the RMD for living expenses.
In these cases, they can roll the RMD directly into a taxable personal account or trust account to continue to be invested.
When the RMD is taken, it is typically treated as taxable at their ordinary income rates. If they already have several income streams, some retirees have a distaste for how high their tax bill can be for the year—many often find it to be higher than their tax bills during their working years!
One effective tool to work around this high tax while donating to charity is through a qualified charitable distribution. Although certain requirements must be met to remain tax-free, retirees can plan ahead and choose to give their RMD to a qualified charity instead of taking it personally.
Because this is a gift, the RMD avoids tax if done properly. This also avoids spiking the annual gross income of the retiree, allows them to be generous, and also saves them immense amounts of money on their tax bill. It can be a viable option for many who have no need for additional income from an RMD in any given tax year.
IMAFS Is Here to Help
Gifting and asset transfers can be complex, with very specific rules and requirements.
We recommend always consulting with your tax and wealth advisors concerning which strategies are viable and effective for your personal situation.
Here at IMAFS, we take pride in our team of highly experienced financial planners who guide medical professionals through every phase of the wealth management process. Whether you need help choosing the best 401(k) for doctors or evaluating a medical practice sale price, we would love the opportunity to help ensure that your wealth strategies are seamlessly executed year after year.
