With the potential sunset of the Tax Cuts and Jobs Act forthcoming at the end of 2025, much of the focus has been on the use of one’s exemption amounts before the drop. However, for those of whom that are not currently a threat to having a net worth over the current $13.61M exemption or even the reduced post TCJA exemption amounts, there may still be reasons to explore gifting assets during life rather than post-mortem. The good news is that the Internal Revenue Code provides methods for those seeking to transfer wealth to their loved ones while minimizing tax liabilities through the Federal annual gift tax exclusion found under section 2503(b) of the Internal Revenue Code. Understanding and leveraging this exclusion can be quite powerful to clients and families without even needing to use up any of one’s lifetime exemptions.
Understanding the Annual Exclusion
At its general core, the federal gift tax annual exclusion allows taxpayers to transfer relatively significant sums to their children or other beneficiaries each year without incurring gift taxes. This exclusion amount, which currently stands at $18,000 for the year 2024, is adjusted annually for inflation, making it a valuable tool for wealth transfer planning.
Leveraging the Exclusion
The federal gift tax annual exclusion applies to gifts made to each individual donee on an annual basis. For example, a taxpayer with three children can generally transfer up to $54,000 to them collectively each year, free from wealth transfer tax. Moreover, if a taxpayer is married, then married couples can effectively double this amount through a process known as “gift-splitting,” potentially transferring up to $36,000 to each donee. Thus, for a married couple with three children, the total amount that can be gifted to the children without using their lifetime exemption amounts is $108,000 collectively each year.
The “Present Interest” Requirement
To qualify for the annual exclusion, gifts must represent a “present interest” to the donee, which means that the recipient’s enjoyment of the gift cannot be deferred into the future. However, certain estate planning vehicles, such as irrevocable trusts, can be structured to meet this requirement in order to still benefit from the annual exclusion, provided the terms of the trust agreements essentially ensure immediate access to the gifted assets in some manner or another. These types of irrevocable trusts, often known as Code Sec. 2503(c) trusts or “Crummey Trusts” (named after the famous case Crummey v Comm’r of Internal Revenue, 397 F2d 82 (CA 9, 1968)), enable parents to establish funds for their children’s future while still taking advantage of the annual exclusion at the time of setup.
Unified Credit for Taxable Gifts
While most taxpayers will never make gifts over $18,000 per donee, even if one does make gifts that exceed the annual exclusion amount it may not necessarily incur tax liabilities thanks to the Federal unified credit. This credit eliminates federal gift tax liability on the first taxable gifts made in one’s lifetime, up to the $13,610,000 exemption amount in 2024. Upon a taxpayer making a gift that exceeds the annual exclusion amount, an IRS Form 709 Gift (and Generation-Skipping Transfer) Tax Return is then required to be filed to report the taxpayer’s use of their unified credit. Thus, it is critical to note that when a taxpayer uses their credit against gift tax liabilities during their lifetime, it reduces the availability of the credit for estate tax purposes upon the death of the taxpayer.
Exceptions to the Annual Exclusion Rules
There are also certain exceptions under the annual gift exclusion rules. For example, if a taxpayer pays for the tuition or medical expenses of another, such amounts generally are not capped. Therefore, the taxpayer could make payments exceeding the $18,000 annual exclusion amount and not have to dip into their lifetime unified credit amounts.
Additionally, certain exceptions under the Internal Revenue Code enable taxpayers to frontload gifts to a 529 plan of up to five years. This would allow a taxpayer to gift up to $90,000 to a 529 plan for the benefit of a child or grandchild. While this also would not use up the taxpayer’s unified credit, it would require the taxpayer to file an IRS Form 709 and also prevent the taxpayer from future annual exclusion gifts to that donee over that five-year period.
Planning for the Future
While the current estate, gift, and generation-skipping transfer tax exemptions are in a state of flux with the potential sunset of the Tax Cuts and Jobs Act, the utilization of one’s annual exclusion still remains intact in 2024. Navigating the complexities of the federal gift tax annual exclusion does require careful consideration and expert guidance. By leveraging these provisions effectively, taxpayers can transfer wealth to their beneficiaries while minimizing tax burdens. For personalized advice tailored to your specific circumstances, it is highly recommended that one consult a qualified tax and estate planning professional.
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