Traditionally, the end of the year is the time when wealthy individuals give gifts to other family members, especially to children who are likely to be in lower tax brackets. Not only does such gift-giving coincide with the holiday season, it also lets you beat the deadline for using the annual federal gift tax exclusion. You now can give as many recipients as you like gifts of cash and property totaling up to $14,000 each without paying federal gift tax. If you give as a couple with your spouse, that amount is doubled to $28,000 per recipient.
And if you exceed the maximum annual gift tax exclusion? You’re still likely not to owe any tax on the gift, thanks to a lifetime exclusion that is $5.45 million in 2016. Tapping the lifetime gift tax exemption reduces the amount available to offset possible future federal estate taxes, but the total amount is large enough to leave most people plenty of room to maneuver.
Yet there’s no reason to wait until the end of the year to give away assets. Indeed, earlier gifts are usually better. The sooner assets find their way to the accounts of lower-taxed family members, the less tax erosion will undercut potential investment growth of those assets. If, instead, you postpone gifts until December, more of the income will be taxed to you in your higher bracket. An early gift also might help you avoid or minimize the impact of the 3.8% Medicare surtax on net investment income as well as reducing income tax liability on future sales of the property.
Gift-giving can take many forms, but one approach to consider is using a “Crummey trust” (named for the first person to use this technique in a court-approved case). With a Crummey trust, you transfer assets to a trust and name the lower-taxed family member as beneficiary. Typically, the trust provides a small “window” of, say, 30 days, during which the beneficiary has the right to withdraw the funds. If the window isn’t opened, the assets become subject to the terms of the trust.
Usually, understanding your intention, the beneficiary won’t attempt to use the funds during the 30-day period. But creating this withdrawal power lets the transfer qualify for the annual gift tax exclusion.
In most cases, a Crummey trust will be able to preserve funds for young family members until they reach the age of majority. Or you could set up the trust to last even longer and provide payments to beneficiaries at predetermined intervals. That could help alleviate concerns about spendthrift children and remove the assets from the clutches of creditors.