Gift taxes are the federal taxes on gifts which are paid by the individual who is making the gift, or the donor. These taxes apply whether the donor intends the transfer to be a gift to that individual or not.
Currently, a single donor may give up to $15,000 a year. A married couple may give up to $30,000 per year.
A gift may include cash or assets to an unlimited number of individuals each year without incurring gift tax liability. The federal gift tax is in place to prevent individuals from avoiding the federal estate tax by giving away all of their assets prior to their death.
What is the Tax Treatment of Gifts Made within Three Years of Death?
When an individual passes away, there may be estate taxes which apply to the transfer of their property at their death. An estate tax is a tax on the transfer of the estate from the individual who is deceased, or the decedent, to their beneficiaries, or individuals who are inheriting from the decedent.
This tax is imposed upon the estate itself, not upon the beneficiaries. The total tax which is owed is calculated by adding the fair market value of all of the decedent’s assets, both real and personal property, as of the date of their death.
Before their death, an individual may seek to reduce the amount of estate tax by making gifts to other individuals. This will reduce the total value of their estate.
Therefore, if the estate tax applies at death, it will apply to an estate where the value has been reduced by the amount of gifts which were given to other individuals. A smaller estate is subject to a smaller amount of estate tax compared to a larger estate.
Tax laws do not permit an individual to gift their entire estate if the gifts are made sufficiently close to the individual’s date of death. This prohibition on gifting is intended to prevent avoidance of paying estate taxes.
How Does Tax Law Treat Gifts Made Within Three Years of Death?
According to federal tax law, if an individual makes a gift of property within 3 years of the date of their death, the value of that gift is included in the value of their gross estate. The gross estate is the dollar value of their estate at the time of their death.
A gift which is made during the lifetime of the individual who makes it is called an inter-vivos gift, or a gift between living individuals. A gift, similar to an estate, is subject to tax.
The individual who makes the gift is required to pay the tax, now the individual who receives the gift. The amount of gift tax which a pays while they are still alive is also included in the value of the estate.
When an individual makes a gift, the first $15,000 value of that gift is not taxed. In other words, the first $15,000 of the gift is excluded from taxation.
This exclusion is referred to as a gift tax exclusion. The amount of this exclusion is set by law and can vary from year to year, so it is important to verify prior to giving any gifts.
If a gift exceeds $15,000 in value, then the value of that gift which exceeds the $15,000 is subject to a gift tax. The percentage of that gift tax may range from 18% to 40% of the value of the gift which exceeds $15,000. The amount of this gift tax which is paid will be included in the value of the decedent’s estate, as noted above, if the gift which was tax was made within 3 years of the date of the death of the decedent.
The gift itself is only included in the total estate value to the extent that the gift is more than $15,000. In other words, if a gift is made within 3 years of the decedent’s death and that gift is worth $25,000, only $10,000 of that gift, the amount above the sum which is excluded from tax, will be included in the gross estate.
The gross estate, as noted above, will also increase by the amount of the gift tax which was paid on the gift.
Are There Exceptions to the Rule for Gifts Made Within Three Years After Death?
An individual may set up a revocable trust, or a living revocable trust, to avoid having the value of a gift being included in their gross estate. This is a type of trust which is created by an individual, called a settlor, during the settlor’s lifetime.
In most cases, the settlor may revoke or cancel the living revocable trust as they choose to. In general, if a settlor wishes to control the assets in the trust during the rest of their life, then they can do so.
If the settlor continues to control the trust assets until they pass away, then the assets of the trust are included in the value of the estate. If this occurs, the assets are subject to estate tax. The law regards trust assets which are within the actual control of the settlor at their death to be assets of the estate.
There is one exception to the three year rule requiring the amount of a gift made by an individual within 3 years of their deal to be included in an estate. This exception applies if the settlor of the revocable trust makes a gift of the assets in the trust to another individual during the settlor’s life.
If this occurs, then the value of that gift is not included as part of the gross estate. This exception will apply even if the gift was made within 3 years of the death of the settlor.
How Can I Avoid Paying the Gift Tax?
An individual can avoid paying the gift tax by:
- Donating a gift to charity;
- Limiting any gifts to $15,000 or less as of 2021;
- Giving a gift or leaving money to a spouse;
- Paying another individual’s medical or school expenses; and
- Arranging for the individual receiving the gift, or the donee, to pay the gift tax.
It is important to note that gifts of any amount given between spouses are 100% deductible for gift tax purposes. This is called the unlimited gift tax marital deduction. This only applies to spouses who are United States citizens.
Do I Need an Attorney If I Am Dealing with a Gift Made Within Three Years After Death?
It is essential to have the assistance of an estate lawyer for any issues surrounding a gift made within 3 years after death. Both estate law and tax law can be very complex, especially when they overlap, applying simultaneously.
If you are dealing with tax issues resulting from a gift made within 3 years after death or if you have any questions regarding taxes that you may be required to pay while estate planning, a lawyer can help. Your lawyer can review your situation, advise you of your best options to limit the tax liability on your estate, and assist you with estate planning to implement the options you choose.