Tax legislation formally known as the Tax Cuts and Jobs Act of 2017 increased the lifetime exemption for gift and estate tax purposes to a historically high level ($13,610,000 for 2024). This increase is scheduled to sunset in 2026 and if so, would reduce the lifetime gift and estate tax exemption by approximately half.
To mitigate future estate taxes, making gifts to family and friends during life can be an effective strategy, but it does not have to be a complex endeavor. Continue reading for some simple, but effective, gifting strategies.
Annual Exclusion Gifting
Annual exclusion gifting can be a simple, but significant, way to transition wealth out of an estate. The annual exclusion is an amount indexed for inflation that can be given each year without using any of your lifetime exemption. For 2024, this amount is $18,000 per person. Making annual exclusion gifts can have quite an impact, especially if you have a large family or if done for many years. Let’s consider a grandfather who has two children and four grandchildren. If that grandfather makes annual exclusion gifts to each of these family members in 2024, he will reduce his estate by $108,000 (6 x $18,000). If he is married and elects to split gifts with his wife, this amount can be doubled to $216,000 (6 x $18,000 x 2). If each of his children and grandchildren are married, this amount can be doubled again to $432,000 (12 x $18,000 x 2) if he decides to gift to spouses as well. If these annual exclusion gifts are made every year for five years, the grandfather can transfer more than $2 million to his family members without using any of his lifetime exemption. With an estate tax rate of 40%, this would potentially save more than $800,000 in estate taxes.
Medical & Educational Expenses
In addition to the annual exclusion, there is an unlimited exclusion for qualified educational and medical expenses. This exclusion also can be quite significant. For example, assume a grandmother has two children and four grandchildren and her grandchildren are in college. Let’s further assume that each of her children pays $12,000 per year for health insurance and each of her grandchildren pays $20,000 per year for college tuition. If the grandmother pays the health insurance and tuition on behalf of her children and grandchildren, she could reduce her estate by $104,000 annually (($12,000 x 2) + ($20,000 x 4)) without using any of her annual exclusions, lifetime exemptions, or paying any gift tax.
There are a few limitations to this strategy to take into consideration:
- Payments must be made directly to the medical or educational provider. Payments made to an individual or a trust, for example, will not qualify.
- For the education exclusion, the educational provider must be a qualified educational organization and educational payments must be for tuition to qualify. Payments for room, board, books, transportation, fraternities, sororities, or other nontuition purposes do not apply for the education exclusion.
- For the medical exclusion, payments must be made for qualifying medical expenses. This includes medical care to diagnose, cure, mitigate, treat, or prevent a disease. It also includes health insurance premiums and transportation and lodging expenses that are necessary for the qualified medical care. Any amounts that are reimbursed by insurance do not qualify for the exclusion. Furthermore, cosmetic procedures do not qualify for the exclusion unless they are to correct a birth defect, accident, or issues caused by a disease.
A gift tax return is not required for educational and medical exclusion gifting if there are no other gifts above the annual exclusion amount.
Contribution to Qualified Tuition Plan (Section 529 Plan)
Contributions to a qualified §529 tuition plan can be very beneficial to those who would like to contribute toward educational expenses for individuals who are not currently enrolled in a qualified educational organization. Contributions to §529 plans count toward the annual exclusion; however, an election can be made under Internal Revenue Code §529(c)(2)(B) to spread contributions to a §529 plan in excess of the annual exclusion ratably over five years. This means that for 2024, up to $90,000 ($18,000 x 5) can be contributed to a §529 plan per individual without utilizing any of the lifetime exemption. This amount is doubled to $180,000 if the donor is married and elects to split gifts with their spouse. It should be noted that a gift tax return would be required to make the five-year election.
If you have any questions regarding the above strategies or other gifting strategies, please reach out to a professional with FORVIS Private Client™.