- Know the pros and cons. Gifting can help reduce the size of your taxable estate, but it can have potential tax implications and loss of control over gifted assets.
- Consider setting up a trust, such as an irrevocable trust, when gifting to minor children, as trusts allow for more control of the assets, even after your death.
- If you want your children to continue to carry out your philanthropic wishes to give money to deserving charities, consider a donor-advised fund.
Giving to a loved one or charity can be one of life's greatest joys. But when it comes to gifting, there are some key issues, including potential tax implications, that you'll want to keep in mind in order to make the most of your gift.
"Every client, no matter how much wealth they have, needs to understand that a gift is irrevocable," says Pamela Pirone-Benson, estate planning specialist with Fidelity. "Ask yourself, 'How does it fit into my overall financial picture and financial health? Does it make sense to give up this money? Could it cause financial struggles or issues in the future?'"
Why give money?
Take time to consider why you are gifting. The pros include a feeling of generosity, the ability to make things easier for future generations, and the opportunity to help causes and organizations that you support. "I call it the 'feel good' factor, or the grandparent effect," says Pirone-Benson. "You've worked hard and saved and now you want to give something to your children and grandchildren to help them."
Sander Bleustein, estate planning specialist at Fidelity, adds, "One thing I hear a lot is, 'I want to see them enjoy the money now.'" In other words, why wait until after you die to distribute the money to loved ones?
Another advantage is that gifting can help reduce the size of your taxable estate, and with it, your eventual estate tax liabilities. On the other hand, gifting can have potential tax implications for both the gift giver and even the gift receiver, as well as loss of control over gifted assets. So weigh the pros and cons before you make a commitment.
Know the basics
In 2018, each person is allowed to gift $15,000 each year to any individual. Any amount beyond that will involve using part of your lifetime federal gift tax exclusion, which recently increased to $11.18 million with the new tax regulations. A married couple could therefore give $30,000 to each of their children and grandchildren and anyone else each year without beginning to use that exclusion, which would be a combined $22.36 million.
If you do exceed the annual exclusion amount, you'll need to file a gift tax return and track the amounts given each year. Bleustein notes, "If you work with a CPA, let them know you've made these gifts."
Consider capital gains taxes
Next, think of the income and capital gains tax consequences for the beneficiary of the gift. Not all gifts are treated equally. If you gift cash, generally there are no income tax consequences for the recipient, though there could be gift and estate tax implications to the donor. But if you give appreciated securities, the capital gains taxes can be significant. Also, note that the tax treatment varies widely depending on the person or entity receiving the gift.
Consider a hypothetical $15,000 gift of cash. You give it to a child or grandchild, and they keep the entire $15,000. But a $15,000 gift of Apple stock, for example, held for 10 years and with a cost basis of $2,000 when sold would result in a long-term capital gains tax for people above the 0% capital gains tax rate threshold.1 So, potentially, the gift beneficiary would owe 15% of $13,000, [$15,000 current value - $2,000 cost basis = $13,000 long-term taxable gain] or $1,950 in federal capital gains tax plus any applicable state tax at the time of sale. For example, for New York state residents, it could mean another 6.58%, or close to $850 in tax as applied to the taxable gain. That's approximately $2,800 paid in taxes on the subsequent sale of the $15,000 gift of appreciated stock.
Taxable gifts are not just limited to cash gifts in excess of annual exclusion or securities, however. "Sometimes a gift doesn't take the form of a check to someone," Pirone-Benson explains. "If you pay a premium for a life insurance policy, but your children own the policy, it might be considered a gift and may be taxable." There are some exceptions to the rule; for example, you can pay someone's medical bills, or education tuition directly. In those situations, your payments on behalf of another individual may not be considered a gift for gift tax purposes under the tax code.
Tip: For greater detail on income tax deductions and income-based charitable giving limits for charitable contributions by individuals, read IRS Publication 526.
The role of trusts
Irrevocable trusts can be beneficial to a donor considering gifting to minor children, as trusts allow for more donor control of the assets, even after the donor's death. By setting up a trust, donors can direct how they want the money to be managed, the circumstances under which it can be distributed, and when it should be withheld. Donors can also specify in the documentation whether their children will be able to control the money at a certain age as either co-trustees or as recipients of the full balance of the trust.
As a donor, you may or may not want to appoint a guardian of any minors as trustee. Instead, the trust could include provisions dictating the timing and access, if any, the guardian should have to the trust assets.
An irrevocable trust can also be an effective tool for transferring assets to an adult child, while potentially reducing estate taxes and directing how you would like the assets to be handled after you have passed away. A single trust can cover all your children.
There are many other advantages to using a trust. The money could be protected from lawsuits, creditor claims, and divorce settlements, so long as the trust is structured properly. "It can help ensure that the assets end up where you want them to go, with fewer unforeseen risks," Pirone-Benson says. Make sure you consult an attorney before setting up a trust.
Despite the advantages of using a trust, the added cost and complexity involved means that they may not be appropriate for every situation. Another option to consider for gifting to minor children is utilizing a custodial account such as those established by the Uniform Gift to Minors Act and the Uniform Transfer to Minors Act (UGMA/UTMA). A custodial account allows you to make gifts to an account invested in the child’s name, and the assets in the account can be used for any expense for the benefit of the child.
Consider whether a custodial account or a trust is most appropriate for your situation. One drawback to a custodial account is that your child will typically inherit the money at the age of majority (the precise age depends on state law), which might not be ideal. You might not feel confident that your child will make the most responsible decisions with a large sum of money at that age.
The charitable trust
If you would like to make significant bequests to charity either during your lifetime or at your death, a charitable lead trust (CLT) or a charitable remainder trust (CRT) may make sense.
CRTs and CLTs are similar in that some of the assets go to the charity and some go to a non-charitable party of the donor's choosing. The key difference is when the charitable and non-charitable beneficiaries receive their payments. With a CLT, the charity receives the income interest for a term of years or for someone's lifetime, with individuals receiving the remaining assets at the end of the trust term. On the other hand, with a CRT, individuals receive the income interest, while one or more charities receive the remainder.
Tip: Which type you choose depends on your priorities with respect to estate planning and wealth preservation, how you want the charity to receive the gift, and even the types of assets you wish to donate.
Read Viewpoints on Fidelity.com: Charitable giving that gives back
The donor-advised fund
A donor-advised fund (DAF) is a program of a public charity that allows donors to make contributions to the charity, become eligible to take an immediate tax deduction, and then make recommendations on their own timetable for distributing the funds to qualified charitable organizations.
With charities that have DAF programs, you can make irrevocable contributions to the charity, which establishes a DAF on your behalf. There are a number of public charities, including Fidelity Charitable®, that sponsor DAFs. You can then recommend grants to other eligible charities—generally speaking, IRS‐qualified 501(c)(3) public charities—from your DAF.
DAFs offer flexibility in your timing of your giving by allowing you to front-load your charitable donations. By making a large donation to the account, you can claim a tax deduction in the year of the gift. However, the money needn’t be distributed to the actual charity in the year you make the contribution. You can let the money grow and you can decide later how the money will be distributed.
"This is a great strategy if you are in a high income-tax year. You might be transitioning into retirement and receive one-time deferred compensation payouts or severance payments," Bleustein says. By making an up-front charitable contribution, you could potentially reduce some of those taxes, and you will be set up for future gifting.
Another advantage is that a DAF account can continue to exist after you die. You can potentially pass on your philanthropic activity and have your children continue to carry out your wishes after you die, by granting money from your DAF to deserving charities. You can even name a donor-advised fund as a beneficiary in your IRA.
Focused on education? Think about a 529 plan account.
If your focus is largely on helping a child, grandchild, or other young person pay for education expenses, an Internal Revenue Code Section 529 qualified tuition program, also known as a "529 plan," can be a powerful tool. A big plus with this type of account is that you and your spouse can front-load 5 years' worth of your annual exclusion gifts. Together, you could give 5 times the combined total of $30,000 for 2018, or $150,000, to each of your children or grandchildren without touching your lifetime federal gift tax exclusion for couples of $22.36 million.2
In addition, the 2017 tax cuts expanded 529 plans beyond college to now include the ability to fund up to $10,000 in K–12 tuition per beneficiary per year.
Next steps to consider
Learn about the Fidelity Charitable® Giving Account®.
Get organized with the Fidelity Estate Planner®.
See 5 tax‐savvy ways to make your giving go further.