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The Three Ways To Make Tax-Free Gifts And Why You Should Use Them Soon


There’s been a lot of talk in Congress about slashing the lifetime exemption for estate and gift taxes (currently $11.7 million per person), perhaps reducing it by half or even more. Even if Congress does nothing now, the exemption is scheduled to be cut in half after 2025, unless Congress agrees to keep that from happening.

Because of the higher probability the lifetime exemption might be reduced, estate planners are encouraging many people to consider reducing the value of their estates by making tax-free gifts of assets while they can to the extent the assets aren’t needed to ensure retirement security. Holding the assets might cause them to be subject to federal estate taxes in the future, reducing the after-tax amount available to loved ones.

The tax code provides three ways to make tax-free gifts. Increase your family’s after-tax wealth by using these methods to the extent they fit your estate and family situation.

The first tax-free giving method is the annual gift tax exclusion. In 2021, the exclusion limit is $15,000 per recipient, and it rises to $16,000 in 2022.

You can give up to $15,000 worth of money and property to any individual during the year without any estate or gift tax consequences. You can give in one transaction or a series of transactions. These gifts won’t count against your lifetime estate and gift tax exclusion, and the recipient won’t owe any federal taxes on the gift or gifts.

You can make these gifts to as many people as you want during the year, with a separate $15,000 tax-free limit on the gifts to each person and no aggregate limit for you. A recipient doesn’t need to have any family or other relationship with you.

If you have three children, you can give each of them $15,000, allowing you to remove $45,000 tax-free from your estate. In a married couple, each spouse has a separate $15,000 limit per recipient, or they can make joint gifts of up to $30,000 per recipient.

The main restriction on using the annual exclusion is that only gifts of “present interests” qualify for the exclusion. Basically, this means any gifts with strings or limits attached don’t qualify for the tax-free annual exclusion. You have to give full legal title to the property.

An exception is what’s known as the Crummey trust power, named after the court case that first recognized it.

A Crummey power allows a trust beneficiary to withdraw a gift from a trust within a certain period after the gift is made. The period usually is at least 30 days. If the beneficiary doesn’t request a distribution, the money stays in the trust and is managed and distributed under the terms of the trust.

Some in Congress want to eliminate the Crummey gift, but it can be used for now.

Education and medical gifts are the second method of tax-free giving. There’s no limit on the amount of tax-free gifts that can be made for qualified education or medical purposes.

To be tax-free, education gifts must pay for direct tuition costs and not for items such as books, supplies, board, lodging, or other fees. The gifts must be made directly to an education institution, not as reimbursements to the student or parents.

The gifts can be made on behalf of any individual, regardless of his or her relationship to you, and for any level of education.

Medical gifts also must be made directly to the medical care provider to qualify for the unlimited gift tax exclusion. Payments for any items that would qualify as deductible itemized medical expenses on an individual income tax return qualify for tax-free medical gifts.

Once the annual exclusion and tax-free medical and education gifts are exhausted, you can make additional tax-free gifts using the lifetime estate and gift tax exemption.

The lifetime exemption amount in 2021 is $11.7 million and will be $12.06 million in 2022. In a married couple, each spouse has a separate exemption.

Any gifts you make during life that exceed the annual exclusion and don’t qualify as tax-free medical and education gifts count against your lifetime exemption. The lifetime exemption really is set up as a tax credit. Gifts that don’t qualify as tax-free under either of the first two methods are taxable gifts. You file a gift tax return and use part of your lifetime credit to eliminate the gift tax. The credit amount is set to effectively allow up to $11.7 million of lifetime gifts without owing gift taxes.

To the extent your lifetime exemption isn’t used by lifetime gifts, the remainder is used to reduce estate taxes.

As you’re aware, there are proposals in Congress to reduce the lifetime exemption. Even if none of these proposals is enacted, the current exemption amount is scheduled to be cut in half after 2025 when the 2017 tax law expires.

Most estate planners expect that the lifetime exemption that applies in a year a gift is made will determine whether or not it is tax free. Taxes on the estate shouldn’t be increased if the lifetime exemption is lower when the estate is processed than when you made the gifts.

There are some in Congress and the IRS who want to “claw back” taxes on gifts made at the higher exemption amount if the exemption is lower when the estate is processed. But that idea doesn’t seem to have a high probability of becoming law or being constitutional.

There are other ways to reduce taxes on gifts. These include structuring gifts so they qualify for valuation discounts and using different types of trusts, such as grantor annuity trusts. There also are proposals in Congress to limit or repeal these strategies. Individuals whose estates exceed the current exemption level also should consider making gifts and using these strategies while they still are available to reduce estate and gift taxes.

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