Why Cant I Make a Tax Free Gift?
I often meet with clients who have preconceived notions about gifting assets based on things they have heard from their friends, neighbors, hairdresser, etc. Most of the time the information shared is incorrect, or at least incorrectly applied to their situation. Many clients are unaware that there may be ramifications beyond just making a gift. The purpose of this article is to set the record straight on what you need to be aware of before making that gift you’ve been thinking about.
The most significant advantage to gifting property is that federal estate taxes and probate costs will be reduced because the gifted property is no longer part of your estate. Gifts between U.S. citizen spouses, regardless of amount, are also nontaxable. So, too, are certain tuition and medical expenses that you may make on behalf of another.
For tax purposes, each person is allowed to gift a certain value to any person tax free. The basic rule is that in the year 2011, anyone can give up to $13,000 in money or other property to any number of parties without gift tax. This $13,000 per year, per recipient rule is known as the annual gift tax exclusion. If you are married and one spouse makes a gift of, say, $25,000, to one person, by filing the federal gift tax return the couple can consent to “split” the gift. That way, each spouse is treated as having made a $12,500 gift, so neither will have made a taxable gift. Many clients with significant assets are able to minimize their taxable estate by making such annual exclusion gifts.
Also under the current rules, even if a gift-tax return must be filed because more than $13,000 is given to one person, the giver of the gift will not pay any gift tax until he or she has gifted more than $1 million during their lifetime. Thus, if a person has $100,000 and gives all of it away in one year to one person, they will need to file a gift tax return, but they will not owe any gift tax because the gift does not exceed the lifetime threshold.
In order to achieve the advantages of gifting, however, you must relinquish all control over the gifted property. The gift must be made with no strings attached. This means that the property could be at risk if your child goes through a divorce, becomes sued or files bankruptcy. In addition, you may end up needing the property for your care and be unable to access it. Before making a gift, you must be sure that the assets you retain are sufficient to enable you to withstand any unexpected increases in your own living expenses.
Another factor to consider is possible adverse effect on family members. If you add your child’s name to your bank account because he or she is going to help you pay your bills, you have made a gift. This could count against them if they need to apply for financial aid for their children or for themselves. Family relations may also be jeopardized especially where one child sees the gifts as being made in unequal portions or where the children cannot agree on what to do with jointly held property.
If you give real estate to a child, there may be negative tax consequences for them when the property is sold. For example, suppose you purchased your home for $30,000 but the property is now worth $250,000. Your basis in the property would be $30,000. If you sell the property, you would realize a $220,000 gain. You would not owe any taxes because of the capital gains exclusion. If you were to make a lifetime gift of this property, your children would take your basis in the property. If they were to sell the property for $250,000, they would realize a $220,000 gain which would be taxable. If, however, you were to die owning the property and leave it to your children in your Will, your children would receive a “stepped-up” basis. They would inherit the property as of the date of death value. If the property were valued at $250,000 as of the date of your death, your children would receive it as if they paid $250,000 for it. As such, they could in turn sell it for $250,000 and realize no taxable gain.
Making gifts can also have an impact on your eligibility for nursing home medical assistance. Any transfer of any asset for less than fair consideration within the lookback period of applying for Masshealth (Medicaid) benefits creates a penalty period of ineligibility. This penalty results in being unable to obtain MassHealth benefits for at least five years after such a gift is made. It is important to note that there is no maximum penalty period and the penalty period does not start until the applicant has applied for Masshealth and has been determined to be eligible.
This penalty provision applies without regard to the reason for a gift. Any gifts you make within 5 years prior to applying for MassHealth coverage of nursing home costs, are presumed to be for the purpose of depleting your life savings in order to qualify for MassHealth. Donations to one’s church, writing a check to a family member for a special occasion such as a birthday or graduation, signing a deed over to someone, paying for a grandchild’s college tuition, etc. are all penalized. There is generally no exclusion for these types of transfers no matter how noble or small they may be. Any and every gift is subject to the penalty period whether it is $5,000 or $500. In order to avoid the imposition of the penalty period, either the gifts would have to be returned to the applicant or the applicant must prove that the gifts were for a legitimate purpose and that nursing home care was not foreseeable based on his or her good health at the time the gift was made.
Many people put their children’s names on their homes, bank accounts, stock portfolios, annuities, and other investments to avoid probate on their death. These changes may cause problems in obtaining MassHealth benefits. Another popular transaction is taking a joint account and removing the MassHealth applicant’s name from the account. This is a gift. The MassHealth applicant had unrestricted access to the full value of the account on one day and after his or her name was removed from the account they no longer had access to the account. This transaction results in a period of ineligibility.
It is important to understand that while a person can make a gift of up to $13,000 per person in 2011 without filing a gift tax return, the MassHealth program is not governed by the gift tax rules. Those same gifts that you make to minimize your tax burden with the IRS will be deemed disqualifying transfers for MassHealth purposes, resulting in a penalty period based upon the total amount gifted.
There are a few very narrow exceptions of transfers that do not create a MassHealth penalty. You are allowed to give any amount of your assets to your spouse. And gifts to a disabled child are not considered transfers that cause MassHealth ineligibility. You may also gift your home to certain people without penalty. Moreover, if you wait long enough after making a large gift before applying for MassHealth, the gift will not be counted.
Although well intentioned, a gift may have serious consequences on your future security and eligibility for long-term care benefits. It may also adversely impact the recipient. Before making a gift, it is vital that you seek legal advice so you can go into the transaction fully aware of the consequences of the gift, and the best way to structure the transaction to insure that you, your children and your property are protected.
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