According to the Charities Aid Foundation’s World Giving Index, over the past decade the United States was the most generous country in the world. Consistently high numbers of Americans (i) help a stranger, (ii) donate to charity, and/or (iii) volunteer, especially during the holiday season.
If this alone was not cause for celebration, there are ways to help family and friends and support your favorite cause that are entirely tax-free and, in some cases, might save you money. This post will explain some of the more popular gifting strategies so that you can receive the joy that comes from giving and better understand the tax consequences of doing so.
- Annual Exclusion Gifts: Generally, anything you give to someone other than a spouse, charity, or dependent child is a gift that must be reported on a gift tax return and subtracted against your lifetime exemption amount, which is currently $12.92 million. An exception to this rule is what are called “annual exclusion gifts.” The current annual exclusion amount is $17,000 per taxpayer per individual. In other words, you can give $17,000 to as many people as you want without having to file a gift tax return. These gifts are usually made in cash but can be made to specific types of trusts to gain the benefits of creditor protection and transfer tax-free appreciation. Married couples can gift up to $34,000 by either making separate $17,000 gifts or electing to split gifts equally, known as “gift splitting.” However, couples should use caution when gift splitting because gift splitting requires the filing of a gift tax return and the couple must split all gifts they make that year, not just annual exclusion gifts.
- Gifts for Educational and Healthcare Expenses: The payment of another’s healthcare or educational expenses is not subject to gift tax, regardless of amount. To illustrate, if grandparents pay their grandchild’s $20,000 hospital bill, there will not be a gift. However, for this exception to apply, the payment for educational or healthcare expenses must be made directly to the service provider. Returning to the previous example, the grandparents only avoid a gift if they make the payment directly to the hospital. In other words, there would be a taxable gift if the grandparents wrote the grandchild a check, the grandchild deposited the check, and then used the funds from the account to pay the medical bill.
- Contributions to 529 Plans: Colorado, along with many other states, has a 529 savings account plan available to residents. The money in the account can be used to pay certain expenses at an eligible educational institution, typically a college or university, but also certain primary and secondary schools and certified apprenticeships. There are no federal deductions for 529 contributions and they do not qualify as payment of educational expenses. Still, any appreciation earned in the 529 is tax-free, distributions for qualified expenses are not subject to tax, and, for Colorado residents, there is a state income tax deduction for amounts contributed to Colorado’s 529 plan. Currently, this deduction is $20,700 per taxpayer, per beneficiary for single filers, or $31,000 per taxpayer, per beneficiary for joint tax return filers. Finally, contributors to 529 plans can take advantage of a gift tax provision that allows for up to 5 years of annual exclusion gifts to be made in a single year. At current amounts, this provision allows a married couple to contribute up to $170,000 to a 529 in a single year, provided they make no additional contributions for the next 5 years.
- Charitable Contributions: By far the most common method of supporting a charity is with cash. Cash donations to charities are an eligible itemized deduction, up to 60% of adjusted gross income (“AGI”). Any amount over this threshold can be carried over for the next five years, subject to the same 60% AGI requirement. In contrast, if appreciated assets (e.g. stocks) are donated, then the AGI limitation is 30%. Even though the AGI limit is lower for donations of appreciated property, neither the donor nor the recipient charity will have to pay capital gains taxes on any appreciation. Thus, donating appreciated stock can be a good way to “reset” a portfolio by donating stock with a low-income tax basis and buying the same stock at a higher basis.
- Qualified Charitable Distributions: For those who are over the age of 70 1/2, another option for charitable giving is to make a distribution from an IRA (except from a SEP or SIMPLE IRA to which employer contributions are still being made) directly to a qualified charity. These distributions have four benefits. First, the annual amount (currently $100,000) may be donated every year. Second, a qualified charitable distribution does not count towards the limits on charitable deductions for those who itemize and may be used by those who take the standard deduction. Third, a qualified charitable deduction can be used to satisfy a required minimum distribution and, if made, does not count towards taxable income. By way of illustration, if someone must take a required minimum distribution of $10,000 and instead makes a $10,000 qualified charitable distribution, then no further distributions are required and the $10,000 is not recorded on the individual’s tax return as income. Fourth, a qualified charitable distribution from traditional IRAs avoids income taxes entirely because (i) the contributions were pre-tax, (ii) the assets appreciated tax-free in the IRA, and (iii) the charity will not pay tax on any amount it receives.
The advice given in this post is educational and provides only a general overview. If you have questions about your specific situation or would like to speak with one of our estate planning attorneys, please contact Alex Kirven at 720-443-4892 or by sending an email.