5 myths about gift tax laws


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5 myths about giving away money

It’s the one-size-fits-all gift that always fits: money.

Who doesn’t want to receive a generous gift from a rich relative? And who doesn’t daydream about winning the lottery and sharing the bounty with a few friends or family members?

For wealthy individuals, gifting is a tool used to pass along their affluence without incurring hefty estate taxes. Plus, they can actually watch their loved ones enjoy it.

But gifting has spawned a handful of pervasive money myths. Experts share the top five.

Myth No. 1: Gifts are income tax exempt

“Everybody thinks this, and everyone is wrong,” says Barry Picker, CPA, with the firm of Picker & Auerbach CPAs based in New York. The real truth: The giver has to pay income taxes on money given away, just as he or she would on any other income.

But this is one case in which it is better to receive than to give: For the person getting the money, it is tax-free.

“If I give my (grown) child $10,000, it has no consequences on their tax return — it’s not income,” says Peggy Cabaniss, CFP, president of HC Financial Advisors in Lafayette, Calif., and former national board chair of the National Association of Personal Financial Advisors. “And it’s not a deduction for me.”

The giver, however, could get a tax deduction if the gift is made to a recognized, registered charity. (And, no, needy relatives don’t count.)

Myth No. 2: Gifts are limited to $13,000

Wrong again, says Picker. You have a $5 million lifetime limit — though Congress could change the law when this provision expires at the end of 2012. Give money to one person or many, all at once or over years; it’s your choice. But anything over that limit nets the giver a 35 percent tax on the gift, he says.

If you want to give more than $5 million in your lifetime, there is a way: Annual gifts to individuals of $13,000 or less don’t count against your $5 million lifetime limit. So you can give someone $5 million one year, and $13,000 every year after that, and never exceed your lifetime gifting limit.

In fact, you can give $13,000 each to as many people as you want every year without raising Internal Revenue Service eyebrows. Married folks can give $26,000 to a single individual by “gift-splitting.” But if you give more than the annual exclusion amount, you’ll have to file Form 709.

Also exempt from the cap: money for medical care or education that the giver pays directly to the institution. So instead of giving your nephew $20,000 for college, you can write that check directly to Harvard University.

Other wealth-type goodies, such as land, jewelry and stocks, are also included in the annual and lifetime gifting limits, says CFP Jill Gianola, owner of Gianola Financial Planning and author of “The Young Couple’s Guide to Growing Rich Together.”

Myth No. 3: If you don’t give it, Uncle Sam gets it

Not necessarily, says Cabaniss.

“People used to be encouraged to gift for estate-planning reasons,” she says. That’s because amounts in an estate that exceeded $1 million were subject to estate tax, which often exceeded 40 percent, says Cabaniss.

The rules have changed repeatedly over the past decade. But here’s how it now stands: Whatever you don’t use of the $5 million lifetime gift exemption counts toward the estate tax exemption. Because the gift tax and estate tax exemptions are tied together for a total of $5 million, it’s called a “unified credit.”

“There are a lot of people with estates of less than $5 million, and they don’t need to be encouraged to gift for estate tax (purposes),” Cabaniss says. “It puts a whole different spin on the reason for gifting.”

One caveat: The new $5 million estate tax exemption and 35 percent estate tax rate are in place until the end of 2012. And no one knows what will happen after that, Cabaniss says. So whatever estate plans you make, it pays to revisit them annually.

Myth No. 4: All gifts are treated equally

“Not all gifts have the same tax consequences,” says Cabaniss.

Give someone $10,000 worth of stock, and the recipient pays no taxes at the time of the gift, says Cabaniss. But when the recipient sells the stock, he or she owes taxes on all of the appreciation (or capital gains) since the time it was originally purchased (when you bought it).

Say you have twin girls graduating from college. You give one $10,000 in cash. Cash value received from your gift: $10,000.

You give the other $10,000 in stock that you purchased years ago for $1,000. She sells the stock later that year. Next April 15, she owes taxes on $9,000 worth of appreciation. At the capital gains rate of 15 percent, that’s $1,350. Cash value received from your gift: $8,650.

One problem: Recipients “don’t really know they are supposed to ask the cost basis (original price) of their gift,” says Cabaniss. And unless you can prove the original price, your recipient will be required to pay capital gains taxes based on the full value of the item when he or she sells it, she says.

And that’s true with land, stocks or “anything that is called a capital asset,” says Cabaniss.

Myth No. 5: An interest-free loan is not a gift

You loan your son $21,000, but you’re not charging interest because he’s your son. It’s still a loan, right?

Unfortunately, it would probably be considered a gift, says Gianola. If you want it to be considered a loan, you have to truly treat it like a loan, she says.

“Have him sign a promissory note,” says Gianola. “And you have to charge market-rate interest. But interest rates are low now. So you could say ‘a good interest rate at a bank is 3 percent, so I’m going to charge him 3 percent.'”

Lay it all out in writing. Stipulate the amount, the interest rate and — also important — the repayment schedule, she says.

The IRS publishes acceptable interest rates monthly on its website.

What if you later change your mind and decide to forgive the loan? In that case, says Gianola, it would be considered a gift.