The federal government imposes a tax on gifts. However, as the law does not concern itself with trifles Congress has permitted donors to give a “small” amount to each beneficiary of their choosing before facing the federal gift. This amount is known as the annual exclusion amount, which for 2021 is $15,000 per beneficiary. Below is an explanation of annual exclusion gifting, along with some other considerations for you to discuss with your tax and legal advisors. As one court has stated:
In providing exemption or exclusion of $5,000 [now $15,000] in respect of each gift, Congress had [intended by passing § 504(b) of Revenue Act of 1932 (predecessor to 26 USCS § 2503) to obviate the necessity of keeping an account of and reporting numerous small gifts, and on other [hand] to fix the amount sufficiently large to cover, in most cases, wedding and Christmas gifts and occasional gifts of relatively small amounts.
Not all gifts qualify for the annual exclusion. A gift must be of a “present interest in property” to qualify for this exclusion from the gift tax. These are gifts that the beneficiary can access and use immediately. For example, if you give a $100 bill to your grandchild (unless intercepted by a parent) your grandchild could run to the local candy store and immediately spend the money. Such a gift would qualify for the annual exclusion and in due course would make the family dentist very happy. On the other hand, a gift in trust that benefits your grandchild only if a trustee makes a distribution from the trust cannot be readily accessed by your grandchild and would not qualify for the annual exclusion.
The value of all gifts made during the year to a single beneficiary count towards the donor's $15,000 annual exclusion, no matter what their form. Thus, if you give your child a $10,000 automobile, you have used $10,000 of your annual exclusion and have $5,000 left to give that child within the annual exclusion amount.
Special rules apply to married couples. Two spouses can “split” a gift to a single beneficiary and treat it as if one-half of the total was made by each spouse, no matter which spouse actually made the gift. This technique allows one spouse to make gifts using both spouses’ annual exclusions, for a total gift of $30,000. To qualify for gift splitting, the spouses must file federal gift tax returns signed by both spouses consenting to the split, even if a return would not otherwise be necessary were each to give $15,000 individually.
Of course, an outright gift of money or property to the donee will likely qualify for the annual exclusion, as the donee would probably be able to use the gift immediately. If making a gift of cash by check close to the end of the calendar year, the check should be cashed before December 31. The gift will not be complete if the donor can control the funds. Because the donor may be able to stop payment on the check, under state law, the donor may still control the funds, rendering the gift incomplete. Although, in one case (based on specific circumstances) the US Tax Court allowed year-end checks from a donor deposited before December 31, but cleared through the bank thereafter, to be considered gifts in the year in which the checks were delivered it is best not to create uncertainty. If making a cash gift right at the end of the year, to avoid any question as to when the gift is complete, consider using a certified check, bank check, or, perhaps, a prepaid gift card.
A minor, being under the age of 18, cannot own property. Nevertheless, this does prevent gifts to the minor that qualify for the annual exclusion. There are many vehicles that can hold a minor’s property. Gifts to such a vehicle can qualify for the annual gift tax exclusion. It is beyond the scope of this article to review the technical rules that apply to each vehicle and how to create it; but, below is a list of vehicles that can be used. You should discuss which of these makes sense for you and your family with your attorney, accountant, or other tax advisors before creating or using a gifting vehicle.
- Uniform Transfers to Minors Act Account (UTMA). An account created under a state’s UTMA, also known as a custodian account, allows an adult to be custodian of a minor’s property. The property in the account belongs to the minor, although it is invested and managed by the custodian. The property in the account may only be distributed to for the benefit of the minor. UTMA accounts are easy to create and fund; however, the funds in the account must, generally, be distributed to the minor when the minor attains age 18 or 21 (depending on the terms of the account and state law).
- Section 529 Plan. An account created under a Section 529 plan allows an adult to manage funds for a minor in a tax-advantaged college savings account sponsored by a state. Funds in the plan may be used to pay educational expenses at eligible institutions (most accredited colleges and graduate schools, including professional and trade schools). Payments for non-tuition expenses, including books and room and board may be allowed for those attending at least half time. As of 2018, up to $10,000 from a Section 529 plan (per person, per year) may be used to fund tuition (only) for private primary and secondary education. Also, at this time, certain student loan debt may also be paid from a 529 plan. Although setting up a Section 529 plan is relatively easy, there are penalties if funds are withdrawn for purposes other than allowed educational expenses. Additionally, investment options may be limited and moving between funds is restricted. If the donee ultimately does not use the funds, the beneficiary of the Section 529 plan can be changed to certain other family members.
- Achieving a Better Life Experience (ABLE) Account. According to the Social Security Administration: an ABLE account is “a type of tax-advantaged savings account that an eligible individual can use to pay for qualified disability expenses. The eligible individual is the owner and designated beneficiary of the ABLE account. An eligible individual may establish an ABLE account provided that the individual is blind or disabled by a condition that began before the individual’s 26th birthday.” Each beneficiary may have only one ABLE account; funding from all sources each year is limited to one annual exclusion amount (for 2021, $15,000), plus, in the case of any contribution by a designated beneficiary who is an employee and for whom contributions to certain qualified plans are not made before January 1, 2026, the lesser of (i) compensation includible in the designated beneficiary’s gross income for the taxable year, or (ii) an amount equal to the poverty line for a one-person household, as determined for the calendar year preceding the calendar year in which the taxable year begins.
As described above, gifts to trusts may not qualify for the annual exclusion absent a special rule or a provision in the trust document that allows the transfer to be a present interest in property. There are two commonly used trusts that allow gifts in trust to qualify for the annual exclusion. Trusts take time, consideration, and the advice of an attorney to create and fund. The trust instrument sets the rules for managing the trust property and when, if ever, it should be distributed to its beneficiary. Nevertheless, certain terms must be included in the trust instrument if gifts to the trust will qualify for the annual exclusion.
- Minor’s Trust under Section 2503(c). A minor’s trust can be created for a beneficiary under the age of 21 pursuant to Internal Revenue Code Section 2503(c). Gifts to the trust will be treated as gifts of present interests in property, qualifying for the annual exclusion, notwithstanding the trustee controls the use of the property in the trust. To qualify as a Section 2503(c) minor’s trust, prior to the beneficiary attaining age 21 distributions may be made only to the beneficiary, the beneficiary must be able to take all property from the trust at age 21, and if the beneficiary dies before attaining age 21, the value of the trust property must be included in the beneficiary’s gross estate either by being paid to the beneficiary’s estate or pursuant to a general power of appointment held by the beneficiary. The right to withdraw the property at age 21 may be for a limited time and if the beneficiary does not take the property, the trust may continue for a longer period of time. Of course, the beneficiary must be aware of the right to empty the trust. As with the UTMA account described above, the beneficiary of a minor’s trust can receive the trust’s assets at age 21, which may not be desirable should the value of the trust be substantial.
- “Crummey” Trust: A so called “Crummey” Trust is a trust that allows the beneficiary (or an adult acting on a minor beneficiary’s behalf) to withdraw a gift to the trust for a limited time after the gift is made. The technique was first approved in the case of Crummey v. Comm’r, and the name stuck. The beneficiary (or an adult, generally a guardian, if the beneficiary is a minor) must know about the right to take property from the trust, or the gift will not be a present interest in property and will not qualify for the annual exclusion. Of course, there is the danger that the gift will actually be taken from the trust. A Crummey trust may continue beyond the beneficiary attaining age 21. Sometimes, depending on the value of the trust, the lapse of the beneficiary’s power to withdraw property from the trust could cause the beneficiary (even if the beneficiary is a minor) to make a taxable gift. Accordingly, care should be used when deciding when and how much of a beneficiary’s withdrawal right should lapse in any one year.
Gifts to grandchildren and more remote descendants could also cause the imposition of a generation-skipping transfer tax (GSTT). This is an additional tax imposed on gifts made to persons two or more generations below the transferor.
Outright gifts to a grandchild or more remote descendant up to the annual exclusion amount are nontaxable gifts and are generally not subject to the GSTT. Unfortunately, gifts made to a trust for a grandchild do not qualify for this treatment.
In order for a gift in trust to qualify for the GSTT annual exclusion, the trust must be for a grandchild or more remote descendant and must have the following terms: during the life of such beneficiary, no portion of the corpus or income of the trust may be distributed to (or for the benefit of) any person other than the beneficiary, and if the trust does not terminate before the beneficiary dies, the assets of such trust will be includable in the beneficiary’s gross estate.
Always remember to consult your attorney with respect to the law of your state when making gifts. Connecticut is the only state which imposes a gift tax. However, the timing or amount of gifts made during life could affect the donor’s estate or inheritance tax return following the donor’s death.
For more information, please consult your PNC Advisor or contact PNC Private Bank.