Wealth Transfer and the Gift Tax Exclusion

As the season of giving approaches, so does the deadline to take advantage of this year’s annual gift tax exclusion — which can be used as a win-win, tax-saving estate planning tool.

Under U.S. tax law, an individual may make a tax-free gift of up to $18,000 per person to as many people as they desire each year.¹ While the recipient of such a gift will undoubtedly benefit from this transfer, using the annual gift tax exclusion can also benefit the donor by potentially reducing their estate taxes.

In other words, if you think your assets may be subject to estate tax,² gifting to multiple people each year may significantly reduce the value of your estate at the time of death and therefore, lower taxes. Not to mention, you may also have the pleasure of seeing your beneficiaries enjoy your gifts.

Gift splitting between spouses

Married donors enjoy an additional tax benefit that allows them to effectively double the annual exclusion. As long as both spouses agree, the IRS allows a gift to be split with half of the gift attributed to each spouse. Thus, a married couple may make an annual gift of up to $36,000 to another person without incurring gift tax.

Gifts to Crummey Trusts

There’s no requirement that an annual exclusion gift be made outright. If you have concerns regarding your loved one’s ability to manage their assets or want the funds to be preserved for future use, you can make the gift to an irrevocable trust created for them. This method of giving is especially useful if you’d like the gift to increase in value over time.

Making a gift to a trust allows you to set specific terms limiting the beneficiary’s ability to access the gift and protecting the trust assets from potential creditors. However, there is one small caveat: For the gift to qualify for the annual exclusion, it must be considered a gift of a present interest.³ To meet this requirement, the trust must provide for beneficiary withdrawal rights, colloquially termed “Crummey Rights” after the tax case⁴ that supported this rule. These rights require that the trust beneficiary receive notice of any gift made to that trust and be given the ability to withdraw the assets for a period of time (that time period may be limited by the trust terms, often 30 days from the date the gift was made). However, because beneficiaries rarely exercise this right, the assets become subject to the terms of the trust after the time period ends and are then held pursuant to the donor’s wishes.

Gifts to custodial accounts for minors

In situations where the recipient is a minor, some donors may find that a custodial account is an appealing vehicle to hold annual exclusion gifts. Typically, these accounts are referred to as “UTMA” or “UGMA” accounts, as they are created pursuant to the Uniform Transfers to Minors Act and the Uniform Gifts to Minors Act. They are seemingly advantageous because they accomplish the donor’s desire to limit the beneficiary’s ability to access the assets, but in contrast to creating a trust, opening a custodial account is easier and inexpensive.

However, transferring assets to a custodial account may keep you from accomplishing your estate planning goals. If you are the custodian of an account you have gifted assets to, the assets will remain part of your taxable estate and will still be subject to estate tax upon death. Therefore, if you don’t have a trusted third-party to designate as a custodian, this method of giving is likely not a viable option.

Additionally, these types of accounts typically terminate when the beneficiary reaches age 21, at which point all the assets will be distributed to that beneficiary directly. Consequently, if this young adult does not have the financial acumen or maturity to responsibly manage this gift, the care you took to successfully safeguard the assets while the account was open may be for naught. For this reason, though it may be more costly, it is often far more effective to make annual exclusion gifts to trusts.

Superfund 529 Plans

Because of a special tax rule, many donors choose to use the annual gift tax exclusion to fund 529 Plan accounts for younger friends and family.

A 529 Plan is a type of investment account where the income grows tax-free if the beneficiary uses the funds to pay for certain educational expenses, such as college or private school tuition. Under Internal Revenue Code §529(c)(2)(B), a donor can “superfund” the account with five years’ worth of annual exclusion gifts ($90,000 per individual or $180,000 per couple) at one time without incurring a gift tax liability. The donor need only file a gift tax return specifying that the transfer is made over five years for gift tax purposes. While the money may only be used for limited educational purposes, you can change the beneficiary to certain related parties other than the original recipient without penalty.

Note that, once you’ve superfunded a 529 Plan for a particular individual, any additional gifts made to that same person during that five-year period will be taxable.

Think about the timing

If your intention is to give more than the annual exclusion to a recipient for immediate use, it is important to consider the timing of the transfer. Because the exclusion applies to gifts made within each calendar year, you may want to make two partial transfers over the course of two years instead.

To illustrate, Shirley’s son needs $50,000 to make a down payment on a home. Because Shirley is married, she and her husband agree to split the gift. Now they can give up to $36,000 to her son per year under the annual exclusion. So, Shirley can transfer $36,000 in December and the remaining $14,000 in January of the next year, effectively making two annual exclusion gifts to ensure the entire gift is tax-free.

Other important considerations

There are several practical considerations to be aware of before engaging in any of the above transactions.

First, there may be outside costs associated, particularly if the gift is to be made to a trust. If the trust has not yet been created, you will incur legal fees to draft the documents and form the trust. However, this is a one-time expense and, if you plan on making annual exclusion gifts each year, you can continue gifting to the same trust.

Second, if you are giving non-cash property, such as stocks or valuable artwork, your attorneys may need to provide you with documents to complete such transfer. Additionally, your accountant will likely recommend filing a gift tax return. Although in most cases there is no need to file a gift return for an annual exclusion gift, it is best practice to complete the forms if you are married and elect to split the gift with your spouse, if you are superfunding a 529 Plan account, or if you are giving property that is difficult to value.

Most importantly, be certain that you have sufficient assets to make these gifts without negatively impacting your ability to maintain your lifestyle. Thus, it’s crucial to work with your wealth manager to determine the amount of gifts you can make each year and discuss potential strategies that will work best for you and your family.

Endnotes

¹Pursuant to Internal Revenue Code §2503(b)(2), the annual exclusion amount is to be adjusted for inflation each year, rounded down to the next lowest multiple of $1,000. The annual exclusion is $18,000 per person in 2024.
²In 2024, an individual may transfer up to $13.61 million during life or at death ($27.22 million per couple) without incurring estate or gift tax. Any additional assets will be subject to estate tax at death.
³26 CFR §2503(b)(1)
⁴Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968)

Editor’s note: The annual gift tax exclusion and lifetime estate tax exemption were updated September 9, 2024.