If you have money or property to give away to family or even friends, understand how to make the gift. Your decision can have both practical and tax implications.
If you transfer ownership to property or give cash, the recipient, called a donee, now has unrestricted use of the gift. The donee can spend the money when and how he or she sees fit.
Taxwise, making an outright gift has no income tax consequences to you or the donee. You cannot deduct any gift you make to an individual (only gifts to charity are deductible).
For gift tax purposes (gift tax is a separate tax system from income tax), you can give up to an annual exclusion amount ($13,000 in 2011) per donee per year. There is no limit on the number of gifts you can make annually. If you give $13,000 to six relatives, you’ve given away $78,000 with no gift tax.
If you give a total of more than $13,000 to a person within the same calendar year, the gift becomes taxable. This means that you must figure gift tax and apply a portion of your lifetime gift tax exemption amount of $5 million (for 2011 and 2012). In essence, you won’t pay any gift tax until taxable gifts (gifts over the annual exclusion) exceed $5 million.
Married couples can opt to “split gifts,” which means that if all the money given is from the wife, the husband can agree to treat this as if he gave half. The result: A couple can effectively give twice the annual exclusion amount ($26,000 in 2011).
Trusts usually are used when you make a large gift and have concerns about how the donee will use the money. The trustee, the manager of the trust, holds the gift for the benefit of the donee (called a beneficiary of the trust). The trustee gives money from the trust to the beneficiary according to the terms you’ve laid out in the trust document. (Because of the cost of setting up a trust and annual administrative costs for the trust, it usually does make senses to use a trust when assets to be held in it will be $100,000 or more.)
For example, you can provide that the trustee is to invest the money you gave to the trust and distribute all the earnings to the beneficiary each year until age 21, when all of the funds remaining in the trust are to be given outright to the beneficiary. Alternatively, you can require funds be held in trust throughout the life of the beneficiary and used for his or her education and support.
Why hold funds in trust?
Taxwise, there are no immediate income tax consequences to you or the donee (beneficiary). The trust will have to file an annual income tax return and the beneficiary will be taxed on distributions from the trust (the trust will be taxed on income that is not distributed to the beneficiary).
For gift tax purposes, gifts in trust are more complex than outright gifts. The annual exclusion amount applies only to gifts of “present interests” where recipients have unfettered immediate control over the money. In contrast, gifts in trust usually are viewed as future interests because the recipient’s benefits are postponed.
Crummey power. Gifts in trust can be transformed into present interest gifts by accompanying them with a Crummey power (named after the court case that created it). When funds are placed in trust, the beneficiary is given a window in which to opt to take the gift outright-usually 30 to 90 days. If the beneficiary does not exercise this power within the fixed time limit (as set by you), then funds are held in trust. Still, the mere fact that they could have had the money outright is enough under tax law to make the gift a present interest gift, eligible for the annual gift tax exclusion.
Trusts for minors. Special rules allow gifts made in trust for children to qualify for the annual gift tax exclusion. Discuss these options with a tax practitioner.
Tax Refunds Abound
About 110.9 million refunds were issued to individuals for the 2010 tax year (the most recent year for statistics). The average refund was $2,953. The total amount of refunds was $327.4 billion.
Source: Office of the National Taxpayer AdvocateView all factoids