Gifts For Your Heirs: Know The Difference Between Gift Tax and Estate Tax

When you decide what gifts to leave to your heirs, you will have to delineate a timeline of when they receive their gifts. The decision of when to give gifts solely depends on personal preference, but keep in mind the rules of gift tax and estate tax.

Gift Tax vs. Estate Tax

Gift tax is the tax enforced by the federal government on any transfer of property to an individual without any compensation in return – in this sense “property” refers to any tangible and intangible property. Currently, you are exempt from gift tax on lifetime donations up to $5.34 million. Once your donations go over that amount, they can be subject to taxes up to 40%.

It’s essential to note that this is a lifetime exemption – in other words this is your cap over your lifespan. The $5.34 million lifetime exemption is a renowned figure in estate planning that’s based on the unified gift and estate tax credit.

In any given year, you can also give a tax-free gift of up to $14,000 per recipient without dipping into the basic exclusion – also known as the annual exclusion. However, the unified credit – the federal gift tax and estate tax combined into one tax system – makes it a little more complicated. If you give more than the annual exclusion amount to any one recipient in any given year, most people are qualified to use the unified credit so that the gift counts against your estate. For instance, if you give $15,000 in 2014, $14,000 is eligible for the annual exclusion, and the remaining $1,000 is applied against your lifetime exemption. It also reduces the exemption for your estate when you pass away by the same amount.

Estate tax is the tax enforced by the federal government on any transfer of property – tangible or intangible – by your estate after you have passed away. Your estate tax is calculated by subtracting any deductions you may be eligible for by your gross estate. The net amount is then added to any taxable gifts you have given that have used up your unified credit to produce your taxable amount.

Pros and Cons of Gifting Now versus Later

Giving heirs the money now:

See them enjoy it. This gives you the chance to see the difference it makes in their lives.
Advise them on how they spend it. This gives you the chance to let your heirs know how you’d prefer they spend it.
Give the gift in the form of paying for something. You can pay for something (wedding, education, etc.) rather than giving your heirs the money for it.
Stop giving them the money if you see them using it unwisely and frivolously Giving it to them now allows you to put a stop to the cash flow if you see them spending it unwisely.
Avoid taxes up to a certain amount. For 2014, the IRS permits you to exclude up to $14,000 in gifts per heir. This in turn means you will not have to pay gift tax on gifts up to that amount. If you elect to give a gift beyond that, you’ll need to claim the “unified credit” in order to avoid paying taxes on the gift.

Waiting until you pass away:

You may need the money later. You might need more than you think in order to enjoy your retirement, pay for medical expenses not covered by insurance or cover other long-term care costs.
Ability to change your mind You can always adjust your will to alter the amount you’ll be leaving heirs after you pass away, but you can’t take back money you’ve already gifted. Waiting until you pass away gives you the opportunity to change your mind during your lifetime.
Your heirs might appreciate it more and spend it more wisely. By waiting until you’ve passed away, you give your heirs a chance to make it in the world at a younger age. This may cause them to appreciate the gift more, as they will have earned the money.