Wealth Management Blog

Give Away Gifts with No Gift Tax

By JJ Burns

February 10, 2012

It may be better to give than to receive, but not if you’re giving results in a big bill for estate or gift taxes. Still, there are plenty of strategies for avoiding those levies. Making generous gifts now, while favorable rules are in effect, could be an especially effective way to transfer wealth to the next generation.

One way to make tax-free gifts is by using the annual gift tax exclusion. Currently, this provision in the tax code lets you avoid taxation on gifts of up to $14,000 to as many recipients as you choose. If your spouse joins you, the limit rises to $28,000.

Suppose you have two adult children and three grandchildren. If you and your spouse make gifts of the maximum amount to each of those five people, together you can give away $140,000 (5 x $28,000), completely free of gift tax. And you can continue to provide that amount year in and year out without owing taxes on the transfers.

Meanwhile, you could also help family members by paying tuition or medical expenses on their behalf without tax liability, and those payments don’t count against the annual exclusion.

By making a series of lifetime gifts, you could remove substantial assets from your taxable estate, thus reducing potential estate tax liability for your heirs. Also, if younger family members are in a lower income tax bracket than you are, this strategy may provide additional tax savings if they subsequently sell the property you give away. (One complication here is that investment income received by young children may trigger the “kiddie tax,” with much of the income taxed at parents’ rates. Even then, however, making gifts to children is likely to result in a net tax benefit.)

To further sweeten the pot, current law enables you to transfer up to $5 million of assets (indexed for inflation to $5.25 million for 2013) to family members, either through gifts during your lifetime or through a bequest in your will. This $5 million exemption, which is doubled to $10 million for married couples (indexed to $10.5 million for 2013), was preserved by the American Taxpayer Relief Act (ATRA). Unlike many previous estate tax law changes, this extension under ATRA is permanent.

There are, however, a few potential downsides to consider. First, when you give away property, you no longer have control over it, and that could be a concern if you’re putting money in the hands of those who may be too young to handle it responsibly. Moreover, using part or all of the $5 million exemption ($5.25 million in 2013) to shelter lifetime gifts reduces the amount that could be used to offset future estate taxes.

Planning for how to best transfer money to children and grandchildren can be part of your overall financial strategy. We can work with you and your tax and legal advisors to find an approach that fits your situation.

Don’t Be Trapped by Another State’s Tax

By JJ Burns

January 2, 2012

Do you own a second home in a resort area that you use personally or occasionally rent out? You could be in for a rude surprise at tax time, if the state where the home is located insists you’re a legal resident and must pay income taxes. In some cases, that may trigger hundreds of thousands of dollars of extra tax liability.

Several states, including Arizona, California, Hawaii, and New York, have been challenging the assertions of homeowners who claim to live out of state. A state may maintain that the owners actually reside within its borders, even if they consider the dwelling to be a vacation home. With other cash-strapped states taking notice of these tactics, the trend may well continue and expand.

In one high-profile case, John J. Barker, a Wall Street investment manager, and his wife argued that they were Connecticut residents who made only sporadic visits to a second home near the exclusive Hamptons area of New York. During the tax years that a New York state audit brought into question—2002 through 2004—the Barkers said the home was used by other family members. But the couple spent more than half of each of those years in New York, and the state has assessed a tax bill of more $1 million for the three years and tacked on penalties of around $220,000. The Barkers have appealed the ruling but may eventually have to pay at least part of the bill.

In another recent case, media personality Martha Stewart, too, argued that her legal residence was in Connecticut and her place in the Hamptons was just a second home. But New York prevailed and Stewart had to pay almost $222,000 in back taxes.

The Empire State has a reputation for being one of the toughest states for audits, and it often targets residents of states such as Florida, Nevada, and Texas that have no income taxes. But farmers in the heartland and jet setters up and down both coasts face similar problems. In the worst-case scenario, you could even be hit by taxes from two states on a single property. For instance, the Barkers could be liable for tax on their investment income in both New York and Connecticut (although Connecticut allows a credit against taxes paid to another state).

You may be able to avoid trouble if you clearly establish your residency in a single state of your choosing. Because residency laws vary from state to state, you’ll have to research the method for documenting your legal domicile. At the very least, obtain a driver’s license and register to vote in your home state. And be sure to keep detailed records of your whereabouts, including a summary of frequent-flier accounts, credit card receipts documenting trips between homes, and phone records that you could use to bolster a claim of residency (or of non-residency)