Question

A wealthy couple comes to you asking for advise about transferring property to their children. The are vaguely aware of wills and gifts but do not know many details. I particular they keep asking you "why can't we just avoid the estate tax by giving our kids everything while we are still alive?"

Briefly explain to them why they cannot do this. Specifically, address the following:

The relationship of gifts to estates

How much gift can be given subject to an exclusions

Other taxes that apply to gifts either explicitly or implicitly.

Answer 1

Estate and gift taxes are imposed by the federal government on the transfer of property from person to another, either at death (estate tax) or while the giver of the property is still alive (gift tax). This article provides a brief overview of both forms of transfer.

Estate Tax

Estates are required to file a federal estate tax return if the value of the "gross" estate, minus certain deductions, is above a certain dollar amount ($5.49 million in 2017). The gross estate includes the value of all property in which the decedent had an interest at the time of his or her death -- including such items as real estate, stocks and bonds, mortgages, notes and cash, insurance on the decedent's life, and jointly owned property. If spouses own property in joint tenancy, and one dies, one half of the value of the jointly held property is included in the gross estate of the deceased spouse.

Estate Tax Exemptions

Personal Exemption. The "personal estate tax exemption" allows a certain amount (or all) of a deceased person's estate to transfer free of the estate tax. This has changed over time, reaching the $5.49 million mark in 2017. At any time Congress may increase or decrease this amount, or even repeal the estate tax altogether.

Marital Deduction. A deceased person's estate can pass tax free to a surviving spouse, as long as the surviving spouse is a U.S. citizen and the deceased spouse's interest in the estate passes to the surviving spouse outright (in other words, the property transfers directly to the spouse upon the decedents death).

To understand how the marital deduction and personal estate tax exemption might work in practice, suppose Bob dies leaving an estate worth $12 million. Putting aside community property issues for the moment, assume that his will states that $6.49 million go to his wife, and $6.49 million to his daughter Kate. In this situation, no part of the $6.49 million Bob leaves to his wife will be subject to the estate tax (as long as Bob's wife is a U.S. citizen and all the property included in the $6.49 million passes to her outright). Of the $6.49 million Bob leaves to Kate, however, $1 million will be subject to the estate tax (the $6.49 million minus the first $5.49 million that is tax-free under the 2017 personal estate tax exemption).

Other deductions. Other deductions against the gross estate include certain administrative expenses, funeral expenses, claims against the estate, certain taxes and other indebtedness and charitable bequests.

Filing the Estate Tax Return

The executor, personal representative, or person in possession of the estate's assets must file the estate tax return within nine months of the decedent's death. The estate can apply for a six-month extension of time to file, but the taxes must be paid within nine months of the decedent's death. The time for payment of the estate tax may be extended in certain circumstances.

State Estate Taxes

Some states also impose estate taxes. The state in which the decedent lived may impose an estate tax, and states where real estate or personal property is located may also impose an estate tax. The law of each state having any connection to the property in question must be consulted in order to assess any tax consequences associated with the property transfer.

Gift Tax

The gift tax is a tax on the legal transfer of property from one person to another, during the giving person's lifetime. Certain gifts are exempt from the gift tax, including:

• Gifts valued at a dollar amount of $14,000 or less to any one individual in a single calendar year (as of 2017);
• Gifts to a spouse;
• Payment of tuition or medical expenses on someone else's behalf;
• Charitable contributions; and
• Certain gifts to political organizations.

Gift of money: Aggregate value of cash gifts received without consideration during a financial year (FY) would be taxable as other income in the hands of the recipient. However, if the aggregate value of such gifts is less than Rs 50,000, then it would be exempt from tax.

In 2019 and 2020, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it. If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return.

Giving gifts are a way of showing affection and appreciation. However, when the financial value of the gift is substantial, it attracts tax liabilities. There are certain parameters and limits set by the Government in case of gifts. If the gift exceeds those limits, it ceases to be just a gift and is seen as a taxable income.

Points to remember for saving tax by gifting

• Limitations
• If the gift giver and receiver are not relatives, the maximum tax-free amount of transfer is Rs.50,000. If the gift amount exceeds that, then the whole amount, not just the excess, becomes taxable as per the tax slab of the receiver.
  However, gifts of any amount received from or given to any relatives - parents, spouse, your and your spouse’s brothers and sisters, brothers and sisters of your parents and your and your spouse’s lineal descendants are entirely tax-free.The way tax can be saved is by gifting to your parents or parents in law or child who is a major. When you gift the amount, your taxable income still remains the same though. But, the interest they earn from other products by investing this money becomes their independent income. So, assuming that their income is lower, you can rest in peace knowing that the money will not be taxed.
  
  Earlier, before long term capital gains (LTCG) tax was active, one could also invest gift money in Mutual fund or stocks for 1 year and take it out as tax-free income. However, now it is not possible as LTCG tax has been reinstated with effect from 1^st April 2018.
  • Investing through relatives
  • To understand how you can save on your income tax through gifts, you have to know another thing called ‘Clubbing’. There is a misconception that if you gift a certain amount to your spouse or minor child, then that amount is automatically exempt from taxation. This brings us to our next point.
    
    Example of ‘Clubbing’
    Suppose you have an annual income of Rs.10 lakhs. You gift Rs. 1 lakh from it to your wife, you cannot claim that your taxable income is Rs.9 lakhs. You have to pay taxes according to your tax slab on the entire Rs. 10 lakhs.
    
    Now, the Rs.1 lakh gift amount is not considered as your wife’s taxable income. However, if your wife invests that money in, say, a Fixed Deposit (FD) in the bank, then the interest received from that FD will be considered taxable income, not of your wife, but, of you. This phenomenon is called ‘Clubbing’ and is the same if the amount is gifted to your child, who is a minor.