You Can Stretch the Gift Tax Limit by Paying for Education or Health Care

If you want to make a gift to family members but have exceeded the annual gifting limit, there is another way. Payments for a family member’s education or health care expenses are exempt from the gift tax.

The annual gift tax exclusion for 2020 and 2021 is $15,000. This means that any person who gave away $15,000 or less to any one individual does not have to report the gift or gifts to the IRS. Any person who gave away more than $15,000 to any one person (other than their spouse) is technically required to file a Form 709, the gift tax return.

One way for a gift to be exempted from reporting requirements, no matter the gift’s size, is to pay for someone else’s medical care or educational tuition. A payment to a school must be made directly to the school (schools include not just colleges but nursery schools, private grade schools, or private high schools). The payment must be for tuition only–it cannot cover room and board or books. Pre-payments can often be made as soon as the person is admitted to the school. However, if you contribute to someone else’s 529 college savings plan, you are subject to the $15,000 gift exclusion rule. A special regulation in the tax code enables a donor to use up five years’ worth of exclusions and gift $75,000 (in 2021) to a 529 at one time.

With regard to medical expenses, the payment must be made directly to the health care provider or to a company that provides medical insurance. You can pay for the diagnosis, cure, mitigation, treatment or prevention of disease. In some circumstances, you may also be able to pay for transportation or lodging for the person seeking medical care. If the person is reimbursed by medical insurance for the care, the payment is not exempt from the annual gifting limit.

To find out the best way to provide for your loved ones without paying gift taxes, talk to your attorney.

 

How Your Estate Is Taxed, or Not

Congress sets the amount that an individual can transfer tax-free either during life or at death. The current estate tax exemption is so high that very few estates will have to pay an estate tax.

In 2017, Republicans in Congress and President Trump doubled the federal estate tax exemption and indexed it for inflation. In 2021, the exemption is $11.7 million for individuals and $23.4 million for couples. That means that as long as your estate is valued at under the exemption amount, it will not pay any federal estate taxes. The lifetime gift tax exclusion – the amount you can give away without incurring a tax – is also $11.7 million.  But you can still give any number of other people $15,000 each per year (in 2021) without the gifts counting against the lifetime limit. In 2026, the exemption is set to drop back down to the previous exemption amount of $5.49 million (adjusted for inflation).

The gift and estate tax rate is 40 percent. This means that if you transfer more than $11.7 million either during your life or upon your death, your estate will be taxed at 40 percent.

In addition, spouses can leave any amount of property to their spouses, if the spouses are U.S. citizens, free of federal estate tax. The estate tax exemption is also “portable” between spouses. This means that if the first spouse to die does not use all of his or her $11.7 million exemption, the estate of the surviving spouse may use it. So, for example, let’s say John dies in 2021 and passes on $10 million. He has no taxable estate and his wife, Mary, can pass on $13.4 million (her own $11.7 million exclusion plus her husband’s unused $1.7 million exclusion) free of federal tax. (However, to take advantage of this Mary must make an “election” on John’s estate tax return. Check with your attorney.)

The currently high federal estate tax exemption, coupled with the portability feature, might suggest that “credit shelter trusts” (also called AB trusts) and other forms of estate tax planning are needless for other than multi-millionaires, but there are still reasons for those of more modest means to have a trust or do other planning, and one of the main ones is state taxes. Slightly less than half the states also have an estate or inheritance tax and, in most cases, the thresholds are far lower than the current federal one.

Making Gifts: The $15,000 Rule

One simple way you can reduce estate taxes or shelter assets in order to achieve Medicaid eligibility is to give some or all of your estate to your children (or anyone else) during their lives in the form of gifts. Certain rules apply, however. There is no actual limit on how much you may give during your lifetime. But if you give any individual more than $15,000 (in 2021), you must file a gift tax return reporting the gift to the IRS. Also, the amount above $15,000 will be counted against a lifetime tax exclusion for gifts. This exclusion was $1 million for many years but is now $11.7 million (in 2021). Each dollar of gift above that threshold reduces the amount that can be transferred tax-free in your estate.

The $15,000 figure is an exclusion from the gift tax reporting requirement. You may give $15,000 to each of your children, their spouses, and your grandchildren (or to anyone else you choose) each year without reporting these gifts to the IRS. In addition, if you’re married, your spouse can duplicate these gifts. For example, a married couple with four children could give away up to $120,000 to their children in 2021 with no gift tax implications. In addition, the gifts will not count as taxable income to your children (although the earnings on the gifts, if they are invested, will be taxed).

Charitable Gift Annuities

Another way to remove assets from an estate is to make a contribution to a charitable gift annuity (CGA). A CGA enables you to transfer cash or marketable securities to a charitable organization or foundation in exchange for an income tax deduction and the organization’s promise to make fixed annual payments to you (and to a second beneficiary, if you choose) for life. A portion of the income will be tax-free.

The New Tax Law Means It’s Time to Review Your Estate Plan

While the new tax law doubled the federal estate tax exemption, meaning the vast majority of estates will not have to pay any federal estate tax, it doesn’t mean you should ignore its impact on your estate plan.

In December 2017, Republicans in Congress and President Trump increased the federal estate tax exemption to $11.18 million for individuals and $22.36 million for couples, indexed for inflation. (For 2019, the figures are $11.4 million and $22.8 million, respectively.) The tax rate for those few estates subject to taxation is 40 percent.

While most estates won’t be subject to the federal estate tax, you should review your estate plan to make sure the changes won’t have other negative consequences or to see if there is a better way to pass on your assets. One common estate planning technique when the estate tax exemption was smaller was to leave everything that could pass free of the estate tax to the decedent’s children and the rest to the spouse. If you still have that provision in your will, your kids could inherit your entire estate while your spouse would be disinherited.

For example, as recently as 2001 the federal estate tax exemption was a mere $675,000. Someone with, say, an $800,000 estate who hasn’t changed their estate plan since then could see the entire estate go to their children and none to their spouse.

Another consideration is how the new tax law might affect capital gains taxes. When someone inherits property, such as a house or stocks, the property is usually worth more than it was when the original owner purchased it. If the beneficiary were to sell the property, there could be huge capital gains taxes. Fortunately, when someone inherits property, the property’s tax basis is “stepped up,” which means the tax basis would be the current value of the property. If the same property is gifted, there is no “step up” in basis, so the gift recipient would have to pay capital gains taxes. Previously, in order to avoid the estate tax you might have given property to your children or to a trust, even though there would be capital gains consequences. Now, it might be better for your beneficiaries to inherit the property.

In addition, many states have their own estate tax laws with much lower exemptions, so it is important to consult with your attorney to make sure your estate plan still works for you.

IRS Issues Long-Term Care Premium Deductibility Limits for 2019

The Internal Revenue Service (IRS) is increasing the amount taxpayers can deduct from their 2019 income as a result of buying long-term care insurance.

Premiums for “qualified” long-term care insurance policies (see explanation below) are tax deductible to the extent that they, along with other unreimbursed medical expenses (including Medicare premiums), exceed 7.5 percent of the insured’s adjusted gross income.  (The 7.5 percent threshold is for the 2017 and 2018 tax years.  It is scheduled to revert to 10 percent in 2019.)

These premiums — what the policyholder pays the insurance company to keep the policy in force — are deductible for the taxpayer, his or her spouse and other dependents. (If you are self-employed, the tax-deductibility rules are a little different: You can take the amount of the premium as a deduction as long as you made a net profit; your medical expenses do not have to exceed a certain percentage of your income.)

However, there is a limit on how large a premium can be deducted, depending on the age of the taxpayer at the end of the year. Following are the deductibility limits for 2019. Any premium amounts for the year above these limits are not considered to be a medical expense.

Attained age before the close of the taxable year Maximum deduction for year
40 or less $420
More than 40 but not more than 50 $790
More than 50 but not more than 60 $1,580
More than 60 but not more than 70 $4,220
More than 70 $5,270

Another change announced by the IRS involves benefits from per diem or indemnity policies, which pay a predetermined amount each day.  These benefits are not included in income except amounts that exceed the beneficiary’s total qualified long-term care expenses or $370 per day, whichever is greater.

For these and other inflation adjustments from the IRS, click here.

What Is a “Qualified” Policy?

To be “qualified,” policies issued on or after January 1, 1997, must adhere to certain requirements, among them that the policy must offer the consumer the options of “inflation” and “nonforfeiture” protection, although the consumer can choose not to purchase these features. Policies purchased before January 1, 1997, will be grandfathered and treated as “qualified” as long as they have been approved by the insurance commissioner of the state in which they are sold.

How Will the New Tax Law Affect You?

While most of the new tax law – the Tax Cuts and Jobs Act – has to do with reducing the corporate tax rate from 35 percent to 21 percent, some provisions relate to individual taxpayers. Before we get into the details, be aware that almost everything listed below sunsets after 2025, with the tax structure reverting to its current form in 2026 unless Congress acts between now and then. The corporate tax rate cut, however, does not sunset. Here are the highlights for our readership:

  • Estate Taxes.If you weren’t worried about federal estate taxes before, you really don’t need to worry now. With the federal exemption already scheduled to increase in 2018 to $5.6 million for individuals and $11.2 million for couples, the Republicans in Congress and President Trump have now nearly doubled this to $11.18 million (estimate) and $22.36 million (estimate), respectively, indexed for inflation. The tax rate for those few estates subject to taxation remains at 40 percent.
  • Tax Rates. These are slightly reduced and the brackets adjusted, with the top bracket dropping from 39.6 percent to 37 percent.
  • Standard Deduction and Personal Exemption. The standard deduction increases to $12,000 for individuals, $18,000 for heads of household and $24,000 for joint filers, all adjusted for inflation. Personal exemptions largely disappear.
  • State and Local Tax Deduction. Now referred to as “SALT,” this is now subject to a cap of $10,000,
  • Home Mortgage Interest Deduction. The limit on deducting interest on up to $1 million of mortgage interest stays in effect for existing mortgages. New mortgages taken on after December 15, 2017, are subject to a $750,000 limit. The deduction for interest on home equity loans disappears.
  • Medical Expense Deduction. After much outcry in response to the House version of the tax bill, which would have eliminated the medical expense deduction, it survived. And, in fact, it was enhanced by permitting medical expenses in excess of 7.5 percent of adjusted gross income to be deducted in 2017 and 2018, after which it reverts to the 10 percent under existing law.
  • 529 Plans. These accounts permitting tax-free accumulation of capital gains and dividends to pay college expenses can now be used for private school tuition of up to $10,000 a year.

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