Autumn typically sneaks up on us here on the Carolina coast, with beach weather and summer-like temperatures lingering almost until Halloween. Nevertheless, the year is drawing to a close, and that means it’s time to start thinking about end-of-year financial planning.
Why is year-end important? For one very important reason. Most people’s tax year coincides with the calendar year, and the end of the year is a deadline under many provisions of tax law.
Since the end of the year is also holiday time, the season of giving, it’s especially appropriate to start planning now for how to fit gifts into your financial strategy.
I’d like to talk about two broad categories of giving. First is gifts to family members, which fits directly into estate planning. If done carefully, this can start to transfer wealth to the next generations while the donor is still alive. It can reduce the size of an estate that’s subject to probate or avoid death (instead of inheritance) taxes. Under some circumstances, it can even have tax benefits for recipients.
Then there’s the other major aspect of seasonal generosity, contributions to charitable institutions. Besides doing good in the world or local community, these gifts can potentially reduce the giver’s income tax liability.
Each type of gift is governed by very specific guidelines.
The gift tax is often misunderstood. It’s distinct from federal income tax. The key fact to remember is that gifts to family members require YOU to pay this tax — but only if your gift exceeds the $15,000 annual limit for each recipient. Above the $15,000 per recipient exemption, taxable gifts are subtracted from an individual’s lifetime estate and gift tax exemption, which is currently $11.4 million per person. So, of course, the key to avoiding this tax is to ensure that all your gifts to one person don’t exceed that limit. On the other hand, you may want to maximize the amount you can pass on to family members, right up to that limit. In other words, pass on every penny you can without incurring the gift tax. That’s why it’s an excellent idea to review your plans well before the year ends.
It’s also useful to understand a few wrinkles. One is that gifts to a spouse, in any amount, aren’t subject to gift tax. Another is that helping a relative with legitimate medical or education costs isn’t considered a taxable “gift,” either. Finally, gifts of property are counted against that $15,000 maximum. How the property is valued depends on credible documentation. If it’s not stocks or bonds or something else routinely traded on an open market, an independent appraisal may be required to determine fair market value.
If you are giving property instead of cash, remember that your basis in the property is passed on to the recipient. That could potentially make your family member liable for capital gains taxes when the gift property is sold. Here’s how the IRS explains it: Say you bought stock at $10 per share. If you give some of that stock to your children, their basis would also be $10, regardless of what its current market price happens to be. But if the children later sold that stock for $100 per share, they would pay capital gains tax on a gain of $90 per share.
Because the rules are different for property acquired from an estate, it’s a very good idea to consult with a qualified professional to review the pros and cons of passing on property as living gifts versus part of your estate. The specifics about the actual value and price history of property, whether it’s stock or collectables or real estate, will determine the best answer.
Shifting to charitable gifts: now is a good time to review your plans. You will want to be sure your gifts accomplish all the good you want them to, and that you don’t miss out on the tax advantages you’re entitled to. The most common of these is the charitable deduction on your income tax return if you itemize deductions. For some taxpayers, that’s a simple enough matter. But for many, it’s worth consulting with your tax or investment professional. There are maximums, for example, beyond which gifts aren’t deductible any more. And charitable deductions don’t exist in a vacuum; they need to be compared with other deductions, tax credits, and income situations to be sure you’re optimizing both the benefit to the recipients and minimizing your tax burden.
For taxpayers over age 70-and-a-half, there’s another potential opportunity. The law requires that everyone who owns an Individual Retirement Account must begin taking a required minimum distribution after that age. For some, being forced to accept income they don’t need can create a problem by putting them into a higher tax bracket. That in turn can require taxes on Social Security benefits or cause such undesirable consequences as triggering “phase-outs” that reduce the value of various deductions.
A solution is to fulfill the required minimum distribution requirement, or a portion of it, by giving that money to charity, instead of taking it as income. This is called a qualified charitable distribution. It can be as much as $100,000 a year, and can be spread across multiple tax-exempt organizations.
These gifts have some other advantages. By reducing the value of the IRA, they can reduce the amount of the required distribution in future years. And these gifts from an IRA are not counted against the maximum for deductible gifts on your income tax return.
You can’t draw the money yourself and then write a check to your favorite charity. These qualified charitable distributions must be made directly from your IRA to the recipient.
The rules governing these distributions are the same as for the required minimums for those 70-and-a-half and older: they must be made before the end of the tax year. Which gets us back to why right now is the time to be thinking about how your charitable giving fits into your financial picture for the year.
Getting back to gifts to family members: that’s something you can’t do from your IRA. Not yet, anyway. But you may expect to have surplus funds in your IRA, even after taking the required distributions. If you would like members of your family eventually to get those funds, don’t despair. You can leave your IRA to an heir or heirs as part of your estate. The chief tax consequences are that, when they start to withdraw funds, they will be taxed at whatever their rate is at the time.
If you need guidance on how to structure either personal gifts or charitable contributions, this is the perfect time to consult with professionals who know the ins and outs of tax and inheritance law. The experts at Old North State Trust can advise you on strategies for passing assets down to younger generations, setting up and drawing from IRAs, and optimizing your charitable giving to maximize the benefits to everyone concerned.
As Marketing Director, Alyce works to develop, budget, and implement marketing plans, which include advertising, coordination of conferences, special events, and development and maintenance of marketing materials. She also oversees the company’s website, in-house articles, and fostering community initiatives within the organization. Alyce received a BS degree in Interior Design from East Carolina University with a concentration in Business Administration and obtained her teaching certification from UNCW. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
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