Passing Down Wealth Without a Tax Burden

When passing down wealth to your children and grandchildren, you want to avoid taxation as much as possible. iQoncept/ShutterStock

Parents and grandparents give a great deal to their children and grandchildren. One of the most tangible legacies they can give is generational wealth. When passing down wealth, most people want to avoid taxation as much as possible, so as to give the maximum amount to their heirs.

Estate Tax Exemption

An estate tax is applied when the value of the estate exceeds an exclusion limit set by law. This tax is applied based on fair market value, not on what the deceased originally paid for assets. The federal government and some states have estate taxes.

But there is an exemption to the federal estate tax that lets a specific dollar amount pass to heirs tax-free. In 2017, President Donald Trump, through the Tax Cuts and Jobs Act (TCJA), doubled the estate tax exemption from $5 million to $10 million for individuals. This amount is indexed for inflation. Therefore, as of 2022, the estate tax exemption for an individual is $12.06 million, while a married couple has a combined exemption of $24.12 million.

A rollback of the estate tax exemption—to the 2009 level of $3.5 million—was proposed as part of the Build Back Better Act. However, this was not included when the bill passed in November 2021.  Speculation about the proposed rollback led to a frenzy of gift-giving in late 2021.

The Trump estate tax exemption is set to expire on January 1, 2026, and will return to $5 million (adjusted for inflation).

The Gift Tax Exemption

According to the Internal Revenue Service (IRS), a gift is defined as a transfer to an individual where “full consideration (measured in money or money’s worth) is not received in return.” If you are in a position where you will owe estate tax, gifting to your heirs is a great way to reduce taxes.

As of 2022, the annual gift tax exclusion is $16,000 for individuals and $32,000 for married couples. This means that if you have three single children and three grandchildren, you can gift a total of $96,000 in a given year. This gives you a powerful tool when it comes to saving taxes if your assets are over estate tax exemption limits.

The total lifetime gift exclusion as of 2022 is $12.06 million. This means, over your lifetime, you can give away $12.06 million in gifts without having to pay a gift tax. You also will not have to file a gift tax return.

Who Pays the Gift Tax?

According to the IRS, the person who gives the gift is responsible for filing a gift tax return and paying the gift tax.

Educational and Medical Gifts

Gifting can also be done in other ways. For example, if you directly pay your children or grandchildren’s educational expenses, it’s treated as an exemption and is not taxable. The gift must be made directly to the educational institution for tuition purposes to qualify.

Gifts can also be made to pay medical bills. To be exempt from taxes, the gift must be made directly to the hospital, doctor, or other healthcare providers.

Educational or medical gifts don’t count against your gift and estate tax exemption amount.

Gifting Minors and Young Adults

Although many individuals want to gift their young children or grandchildren, there are some concerns with handing over large amounts of assets to a minor.

If you are concerned about assets being spent instead of used on future education, a 529 College Savings Plan might be the route to take. The monies must be used for educational purposes—there is a 10 percent penalty on the earnings if taken out for other reasons. The law allows you to front-load five years of gifting into a 529 College Savings Plan.

A Uniform Transfer to Minors Account (UTMA) is similar to an investment or bank account; only the minor owns it. The gift-giver or an adult custodian handles the account for the youth until the minor reaches legal age for the state in which they live—usually 18 or 21 years. At that time, the account is transferred over to the youth.

Money contributed to a UTMA is exempt from taxes up to the gift tax exemption amount. From an income tax perspective, any income earned on the contributed funds is taxed using the “kiddie tax” rate—which offers some tax protection as well.

The downside of a UTMA is that since the child owns the account, it may negatively impact financial aid for college.

‘Stepped-Up’ Strategies to Reduce Capital Gains for Heirs

The “stepped-up basis“ is a provision that reduces capital gains tax on inherited property or investments.

When these assets are inherited, the IRS “steps up” their cost basis. That is, their market value is reset to the date of the original owner’s death. The heir doesn’t pay capital gains tax on any increase that occurred from the time the deceased purchased the investment or property, to the time that individual died.

For example, let’s say grandmother purchased a stock for $10 a share. When she died, it was worth $15 a share. You inherited the $15 a share stock, but you are not required to pay capital gains on the five dollars the stock earned while grandma was still alive. Why? Because your stepped-up tax basis is now $15 a share. If the stock price goes up further, you’d only need to pay the capital gain on the difference between the new price and $15, instead of on the $10 it cost when your grandmother purchased it.

If your grandmother had sold that stock while still alive, she would have had to pay the capital gains tax on the full difference. By leaving the stock to you instead of selling it and leaving you the proceeds, she was able to save on capital gains taxes and thus potentially leave you more money.

There is a risk to this, of course: the inherited stock could decline in value. In that case, the heirs might wind up losing more money than the IRS would have taken in capital gains tax.

Do Your Homework

You may escape federal estate or gift taxes, but state laws differ and could impact you and your heirs. And upcoming tax-law changes could affect the timing and nature of wealth transfers. When considering your will, be mindful of tax ramifications for your heirs. Naturally, you want to pass down your wealth without the tax burden.

The Epoch Times Copyright © 2022 The views and opinions expressed are only those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.