As the holiday season and the end of 2021 rapidly approaches, many Americans are contemplating their annual gifting strategies. Whether you are considering giving a gift this year as a tax shelter, to reduce your taxable estate, or just out of the kindness of your heart, it is important you understand the various regulations governing gifting and how they will impact your finances.
Charitable gifting can have great impacts both for those in need and the donor. Donations to charitable organizations are tax-deductible for the donor. It may be cumbersome, but always hold on to your donation receipts when you contribute and be aware that contributions are deductible in the year in which they are paid; the deadline is on a calendar year basis. While the recently passed CARES Act extension allows non-itemizers to deduct up to $300 in cash contributions to charity per taxpayer, you must itemize your taxes to take additional charitable deductions. Make sure that if you itemize, your total deductions are greater than the standard deduction, for example the 2021 standard deduction for married filing jointly is $25,100.
For charitable contributions, you can deduct up to 100% of your Adjusted Gross Income (AGI) if the gifts are to a qualified organization. Note that the percentage of your AGI that is eligible for deduction is dependent on the type of organization to which you are donating. For example, contributions to certain private foundations, veterans’ organizations, fraternal societies, and cemetery organizations could reduce your percentage to as low as 20% of your AGI.
If you are 70½ or older, you may consider making qualified charitable distributions (QCD) directly from your IRA. The donated amount, which can be up to $100,000 per year, will be excluded from your taxable income. If you are age 72, this amount will also count toward your Required Minimum Distribution (RMD) for that year. That tax exclusion may also reduce the taxes you pay on your Social Security income and the amount of your Medicare premiums.
Gifting appreciated stock to a charity is another great way to lighten your tax burden as opposed to donating cash. Stocks that have appreciated and been held for longer than 1 year are eligible for a deduction of the full fair market value of the security – not just your cost basis (amount you paid for the security). On top of that, you avoid paying capital gains taxes (currently 20% for the top tax bracket) on the sale of the security.
Another great tool available for charitable donations is a donor-advised fund (DAF), which is a dedicated account established for the sole purpose of charitable giving. Contributions of cash or securities are immediately deductible for the donor but can also be invested and grow tax-free until those assets are granted to a qualified charity of your choosing. This tool is great for reducing the number of small gifts made to charities or for spreading the donations across multiple years. DAFs also allow for charitable bunching, which may help you exceed the standard deduction threshold for a particular year while maintaining a regular schedule of donations to 1 or more charities.
Gifting can also be a great tool for those who are concerned with how their estate will be taxed after they pass away. For those who are looking for the most efficient ways to get their assets to their loved ones, making annual lifetime gifts should be a part of your plan.
The first fact that should be understood, is that the federal gift and estate tax are essentially just one tax. In 2021, an individual can transfer a total of $11.7 million ($23.4 million for married couples) free of tax – this dollar limit is usually referred to as the estate tax exemption or exclusion amount. Every dollar passed to heirs above this limit would be subject to estate tax at 40%.
Please keep in mind that these rules tend to change every time power shifts in Washington; the current Congress and administration may pass a bill this year that would cut these numbers in half. What we do not expect to change in this new law is the annual exclusion amount, which allows for annual tax-free gifts to an unlimited number of individuals.
For 2021, an individual can gift up to $15,000 a year ($30,000 for married couples) to any person or non-charitable institution. For every dollar that an individual or married couple exceeds these limits, their estate tax exemption is reduced by a dollar. For example – if an individual in 2021 were to gift $115,000 to a family member, $15,000 would pass tax-free and $100,000 would be subtracted from their estate tax exemption. Should that same individual pass away, every dollar they left bequeathed over and above $11.6 million would be subject to estate tax.
For those with children and grandchildren who are uncertain about giving significant amounts to minors, you can utilize tools like 529 plans, custodial accounts, or trusts as vehicles for gifting. One advantage of gifting with a 529 is that you can front load the contribution up to 5 years. This allows for the donor to gift 5 years’ worth of the annual gift tax exclusion ($15,000 x 5 = $75,000) to a 529 plan per child. For married couples, this amount doubles to $150,000. The donor is not allowed to donate to that 529 for the next 4 years, but you can remove a significant amount from your taxable estate with one transaction. For wealthy individuals with numerous grandchildren, this can be particularly attractive.
Gift Tax Exclusion
There are options left for those who either have bumped up against their annual gift exclusion limit or do not want to go through the trouble and added complexity of opening new accounts or entities. An exception applies that allows for tax-free transfers for qualifying educational or medical expenses. Payments made to an educational organization or medical provider on behalf of another individual are not treated as taxable gifts. This can be an extraordinary planning tool that can assist relatives with high medical bills or children and grandchildren cover their tuition payments.
Whether your purposes are philanthropic in nature, you want to prevent Uncle Sam from dramatically reducing the legacy you leave, or a little bit of both, gifting can be a very advantageous financial tactic when done appropriately. Should you be considering utilizing one or more of the strategies described above, always seek the advice and council of your financial advisor, accountant, and trust and estate attorney when making these important decisions.