Earlier this year, we wrote about making tax-efficient gifts to charity. Today we are going to discuss why you should give—and how to give—to individuals in a tax-efficient way.

Happiness

What makes people happy, content, and fulfilled? More money and more things can give a temporary boost to someone’s mood, but research has shown that once a basic level of needs is met, financial resources do not increase happiness. What makes most people enduringly happy is having a sense of purpose, building relationships, spending time with family and friends, and making a difference in the world.

As noted in Psychology Today, one important non-monetary pathway to happiness is being kind to others. “Kindness makes you happier, and happier people engage in more acts of kindness.” Speaking from experience, making a difference in someone’s life can cause a rise in your endorphins, resulting in a “helper’s high.”

Helping Others

There are numerous ways, large and small, of expressing kindness to others. If, for you, this takes the form of giving to others directly in the form of money, assets, or services, there are several things you should be aware of:

  1. The gift tax
  2. The generation-skipping tax
  3. Capital gains tax rates
  4. Public benefits
  5. The expiration of the Tax Cuts and Jobs Act (TCJA)

Gift Tax

Gift taxes are paid by the donor, the individual making the gift. Everyone receives a lifetime exemption, currently $13.61 million, and an annual exemption, currently $18,000 per year per person. If the value of the gifts you give exceeds $18,000 per year per person, then you will need to file a gift tax return and use part of your lifetime gift exemption to avoid paying gift tax.

In addition to gifts under $18,000, you can pay an unlimited amount for a person’s medical care or education, with no gift tax consequences, if you pay the facility directly. For example, you can pay your grandchildren’s college bills directly to the school they attend with no gift tax return required or tax due. Likewise, you may directly pay a healthcare provider for your parents’ medical care or an insurance carrier for your adult relative’s health insurance, again with no gift tax return required or any tax due.

A married individual may give $36,000 to an individual in one calendar year without owing a gift tax by adding their spouse’s exemption to their own. In this case, both spouses should file a gift tax return and elect “gift splitting” to avoid paying gift tax and to start the three-year statute of limitations on the tax return.

While in many cases, there may be an immediate need for a gift, such as to assist in a home purchase, the annual exemption may be used to make tax-free gifts to an irrevocable trust that is primarily intended for future needs or for use in estate planning. This is done by use of a “Crummey Power” that allows the annual exemption to be used for gifts to the trust, so long as the beneficiary is notified of the gift and is allowed to withdraw the funds within a limited period of time (e.g., 30 days). Once in the trust, assets may be invested and continue to appreciate outside of the donor’s estate with no further gift or estate tax consequences. When done over years or decades, this type of gifting may allow for the transfer of substantial portions of a donor’s estate with no gift or estate taxes applied.

A common mistake on gift tax returns is not listing all charitable gifts made in that year. This is required only if you are filing a gift tax return for another purpose (such as disclosing large gifts to individuals) and does not result in any tax, but if you leave those gifts off, the IRS could argue the statute of limitations does not apply because the disclosure of gifts was not complete.

Generation-Skipping Tax (GST)

If you make a gift to your grandchild, a special tax known as the generation-skipping tax (GST) may apply. The GST is applied in addition to the gift tax. As with the gift tax, everyone (currently) receives a $13.61 million exemption from this tax as well as an $18,000 per year per person exemption. When filing a gift tax return, it is important to consider the generation-skipping tax implications, as the exemptions and rules vary slightly from the gift tax rules.

The generation-skipping tax applies to gifts to anyone more than 37.5 years younger than the donor.

An important distinction between the GST rules and gift tax rules is that additional provisions must be met for the “Crummey Power” provision discussed above to apply for trusts subject to the GST. The present interest exclusion of $18,000 per year per person generally does not apply to gifts to irrevocable trusts.

Capital Gains Tax Rates

You don’t have to give just cash to an individual—you could also gift appreciated stocks, mutual funds, or exchange-traded funds (ETFs). For high-income individuals, taxes on sales of these types of assets can be as high as 23.8% of associated gains. If the recipient is in a lower tax bracket, they will be able to sell these assets once a gift is completed for a lower rate or with no tax due at all. This is because of the 0% capital gains tax rate in effect for individuals with taxable income less than $47,026 ($94,051 for a couple). This strategy takes a little tax planning, with the recipient’s income in mind, but can be a very tax-efficient way of transferring assets. For example, if you gifted $15,000 worth of stocks (with a built-in capital gain of $12,000) to a couple with $50,000 in W-2 income and then they sell the shares of stock, their total income will now be $50,000 + $12,000 = $62,000, and they will pay no federal income tax on the capital gains. However, additional income can have consequences, and you should be aware of this effect on any public benefits, which we will discuss next.

Public Benefits

Federal and state governments provide support for food, housing, childcare, and medical costs for lower-income individuals and families. For example, in New Hampshire, families whose income doesn’t exceed 220% of the federal poverty level ($66,000 per year) can qualify for childcare scholarships. If a family of four had gross income of $60,000, giving this family $15,000 worth of stocks with a built-in capital gain of $12,000 would result in $72,000 of gross income if they sold the stocks, disqualifying them from this childcare benefit. Food stamp support, subsidized rent, and other benefits use different calculations but could result in the same problem. Every state calculates these benefits slightly differently, so refer to your state’s department of health and human services for specifics.

Additional income or assets can also impact an individual’s ability to qualify for subsidized health insurance and college financial aid. Financial gifts are not usually considered income for these purposes unless the sale of an asset results in taxable income. However, programs that incorporate an individual’s total assets as part of their eligibility criteria will be impacted.

In cases like these it may be a better idea to provide financial support for individuals receiving public benefits by paying their bills directly. This avoids giving them assets or income that disqualifies them from the benefits they are receiving. In cases where you would like to provide extended support without impacting an individual’s benefits for eligibility, specialized trusts may be used with provisions that allow for long-term support without impacting government benefits.

Expiration of the Tax Cuts and Jobs Act

Many provisions of the 2017 Tax Cuts and Jobs Act are currently scheduled to expire at the end of 2025. The pending expiration of these provisions will have far-reaching consequences, including impacting estate and gift taxes. If no action is taken in 2026, the lifetime exemption currently at $13.61 million will revert to inflation-adjusted 2017 levels, about $7 million per person. While legislation may be enacted to extend the current exemption or otherwise increase the amount in 2026 and beyond, advanced planning regarding this possible change to the law is an important consideration for any individual or family impacted by the reduction.

Conclusion

Helping individuals or families through gifting is an admirable goal with benefits to donors and recipients. There is a good deal of support for these activities within the tax code, which provides a wide range of options for transferring wealth free of tax to individuals and charities. When planning for significant gifts, it is important to get information and personalized advice in advance. A well-thought-out plan will ensure that your gifting is done in the most efficient and effective manner possible, that any reporting requirements around the gift are met, and that your generosity is not impacting the recipient’s eligibility for any government benefits. Lastly, it is important to note that many states have estate and gift tax regimes of their own, which need to be considered in the context of your plan.

Giving to individuals can have tax consequences, but you don’t have to go it alone. If you are interested in integrated estate, tax, financial, investment, and retirement planning, please reach out to our team.

Disclaimer: This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Milestone Financial Planning, LLC, (Milestone), a fee-only financial planning firm and registered investment advisor in Bedford, NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services, and have unlimited access to our advisors. We receive no commissions or referral fees. We put our client’s interests first.  If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors.  Advisory services are only offered to clients or prospective clients where Milestone and its representatives are properly licensed or exempt from licensure.

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