How Does Gift Tax Exclusion Work?

How gifts are made could have major impacts on heirs, especially if the recipient is a minor. There are many drawbacks to gifting outright, including limited control over gifts, exposure to creditors, divorce and litigation. Trust options are the recommended strategy, as discussed in the article “The Annual Exclusion For Gift Taxes Has Increased to $16,000—What Issues Should I Consider” from Mondaq.

When gifting directly to minors, a custodial account (ITMA) offers some structure. However, if the account terminates when the minor becomes of age, you then have a young person with no control and a lot of money. This is usually a bad combination.

For example, what if the annual exclusion gift of $16,000 is placed into a custodial account when the heir is nine and ends when the heir celebrates their 18^th birthday? Even if the account earns no interest, by the time the heir reaches age 18, they will have complete access to $160,000 with no restrictions.

If there is a change to the custodian before the minor comes of legal age, the UTMA allows a primary custodian to name a successor. However, if this does not happen, the process of naming a successor custodian is generally burdensome and expensive.

Trust options or a transfer to a 529 plan are better options offering a lot more control by a trustee. Trusts allow assets to be used for a variety of needs, while the 529 plan limits withdrawals to be used for educational needs. The trustee may also continue to manage the account long after the heir has reached legal age, which to most people makes good sense.

Another option is a Section 2503(c) Minors Trust, which can be used for annual exclusion gifts to minors. They require that assets of the trust be applied for the minor who is a beneficiary of the trust. However, there are limited exceptions. There can only be one beneficiary and they must be under age 21. When the beneficiary turns twenty-one, they must be given the ability to withdraw the assets. However, any assets remaining in the trust can be kept in the trust and the trust itself can be converted into another form of irrevocable trust, allowing for continued annual exclusion gifts to be made for the beneficiary.

For more control, consider an irrevocable gift trust. The IGT can be used for the annual exclusion gift and is a smart choice for gifts greater than the annual exclusion when a Gift Tax Return is required. The person creating the irrevocable gifting trust appoints the trustees and should name alternates, if the primary trustee is unable to serve. The trustee then has discretion to manage the assets, including over distributions. Unlike a 2503(c) Minor Trust, the irrevocable gifting trust does not have to terminate or permit unrestricted access to income or principal.

Reference: Mondaq (March 2022) “The Annual Exclusion For Gift Taxes Has Increased to $16,000—What Issues Should I Consider”

What are Earnings Limits for Disability Retirees?

If you are 60 or older, there’s no restriction on the amount of income you can earn while receiving disability retirement.

However, if you’re under age 60, you can earn income from work while also receiving disability retirement benefits. Note that your disability annuity will cease, if the United States Office of Personnel Management determines that you’re able to earn an income that’s near to what your earnings would be if you’d continued working.

Fed Week’s recent article entitled “The Limits on Earnings for Disability Retirees” says that the retirement law has set an earnings limit of 80% for you to still keep getting your disability retirement. You reach the 80% earnings limit (or are “restored to earning capacity”) if, in any calendar year, your income from wages and self-employment is at least 80% of the current rate of basic pay for the position from which you retired.

All income from wages and self-employment that you actually get plus deferred income that you actually earned in the calendar year is considered “earnings.” Any money received before your retirement isn’t considered “earnings.”

The government says that income from wages includes any salary received while working for someone else (including overtime, vacation pay, etc.). Income from self-employment is any net profit you made from working or managing your own business—whether at home or elsewhere. Net profit is the amount that’s left after deducting business expenses and before the deduction of any personal expenses or exemptions as allowed by the IRS. Deferred income is any income you earned but didn’t receive in the calendar year for which you’re claiming income below the 80% earnings limitation.

If you’re reemployed in federal service, and your salary is reduced by the gross amount of your annuity, the gross amount of your salary before the reduction is considered “earnings” during the calendar year.

The following aren’t considered earnings:

Gifts
Pensions and annuities
Social Security benefits
Insurance proceeds
Unemployment compensation
Rents and royalties not involving or resulting from personal services
Interest and dividends not resulting from your own trade or business
Money earned prior to retirement
Inheritances
Capital gains
Prizes and awards
Fellowships and scholarships; and
Net business losses.

If you’re under age 60 and reemployed in a position equivalent to the position you held at retirement, the Office of Personnel Management will find you recovered from your disability and will cut off your annuity payments.

Reference: Fed Week (Nov. 4, 2021) “The Limits on Earnings for Disability Retirees”

Will Inheritance and Gift Taxes Change in 2021?

Uncertainty is driving many wealth transfers, with gifting taking the lead for many wealthy families, reports the article “No More Gift Tax Exemption?” from Financial Advisor. For families who have already used up a large amount or even all of their exemptions, there are other strategies to consider.

Making gifts outright or through a trust is still possible, even if an individual or couple used all of their gift and generation skipping transfer tax exemptions. Gifts and generation skipping transfer tax exemption amounts are indexed for inflation, increasing to $11.7 million in 2021 from $11.58 million in 2020. Individuals have $120,000 additional gift and generation-skipping transfer tax exemptions that can be used this year.

Annual exclusion gifts—individuals can make certain gifts up to $15,000 per recipient, and couples can give up to $30,000 per person. This does not count towards gift and estate tax exemptions.

Don’t forget about Grantor Retained Annuity Trust (GRAT) options. The GRAT is an irrevocable trust, where the grantor makes a gift of property to it, while retaining a right to an annual payment from the trust for a specific number of years. GRATS can also be used for concentrated positions and assets expected to appreciate that significantly reap a number of advantages.

A Sale to a Grantor Trust takes advantage of the differences between the income and transfer tax treatment of irrevocable trusts. The goal is to transfer anticipated appreciation of assets at a reduced gift tax cost. This may be timely for those who have funded a trust using their gift tax exemption, as this strategy usually requires funding of a trust before a sale.

Intra-family loans permit individuals to make loans to family members at lower rates than commercial lenders, without the loan being considered a gift. A family member can help another family member financially, without incurring additional gift tax. A bona fide creditor relationship, including interest payments, must be established.

It’s extremely important to work with a qualified estate planning attorney when implementing tax planning strategies, especially this year. Tax reform is on the horizon, but knowing exactly what the final changes will be, and whether they will be retroactive, is impossible to know. There are many additional techniques, from disclaimers, QTIPs and formula gifts, that an experienced estate planning attorney may consider when planning to protect a family legacy.

Reference: Financial Advisor (April 1, 2021) “No More Gift Tax Exemption?”

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