Thinking About Gifting? Consider an Irrevocable Trust Instead

When it comes to monetary gifts, nearly everyone is worried about the tax man. But actually, the tax man isn’t what should concern you most. Instead, it’s whether gifting is the right strategy for what you want to achieve. Here’s what we mean. 

Will You Pay the Gift Tax? Only if You’re Really Generous 

The number to remember is $15,000. That’s the amount you can give annually to any number of loved ones without needing to report the gifts to the IRS. And remember, that amount is per person, so you and your spouse can each give $15,000 per recipient, for a total of $30,000. 

Now, here’s where people tend to get confused. That $15,000 figure is not the total limit on what you can give tax-free per recipient. It’s simply the limit for what you can give without disclosing it to the IRS.  

There is also a lifetime gifting limit of $11.7 million before the gift tax kicks in. The first $15,000 of each gift is exempted. So, for example, if you were to gift $16,000 to each of your 3 children this year, $3,000 would count toward your lifetime limit (that’s 3 x $1,000, which is the amount over the $15,000 limit on each gift). The $3,000 will also count toward your estate tax exemption (more on that below). As you can see, you’d have to be really generous for the gift tax to affect you. 

Now, it’s important to note that gifts to charity, your spouse, or a political organization are always exempt from the gift tax no matter the amount. So too are gifts to cover someone’s medical expenses, if paid directly to the provider. Gifts to cover someone’s tuition are also exempted so long as the funds are paid directly to the school. Room, board, and books aren’t included. 

What About Gifting After Death? 

It depends on what you’re gifting, because now you have both the estate tax and tax basis to consider. Any gifts less than $15,000 you give during your lifetime won’t count toward your estate tax exemption, which for tax year 2021, is also $11.7 million.  

But let’s say you decide to wait until your passing to distribute your wealth via your will. In that case, the entirety of what you gift after you die will count toward your exemption. However, could it cause some tax headaches for your recipients? Absolutely. This is where the kiddo’s penalty becomes a problem. That’s when your heirs—likely in their peak earning years and therefore in the highest tax bracket of their lives—end up paying taxes on their inheritance at a higher rate than the one you enjoyed during retirement. 

There can be some advantages to gifting after death, however. Take for example, leaving real estate like your home or vacation property to a loved one. This is where something called a stepped-up basis comes into play. If your loved one were to sell the inherited property at some point in the future, their tax bill would be calculated on the property’s appreciation since the date of your death, not since you purchased it. That could yield substantial savings, especially if you’d held the property for quite some time. 

Should You Get Gifting or Get a Trust? 

You might be thinking, “Oh, the kiddos tax sounds bad. I’m going to give away my money while I’m still alive.” There are a couple reasons why that might work against you. 

First, it’s hard to know whether you might need long-term care, and if you do, for how long. LongTermCare.gov estimates a 70% chance you’ll need long-term care if you’re 65 or older. If you do, you’ll want to have a decent cushion to protect you from the cost. The national average for a private room in a nursing home is $7,698 per month. 

So, if you have enough money to give freely and still have a comfortable cushion left over to self-fund long-term care if the need arises, then by all means gift away! But that’s a small percentage of the population. For most of us, large gifts aren’t the norm, and long-term care costs are a source of anxiety. 

Further, most of us (over 60%) go on Medicaid to cover the cost of long-term care. Which brings us to our second point on why gifting may not be the best strategy to reduce your wealth: because Medicaid has a five-year lookback period. If it’s found that you gave away wealth during that period to reduce the value of your estate to become Medicaid eligible, you may not qualify for coverage.  

You do, however, have one other choice to consider: an irrevocable trust. For this situation, one of the most popular is an asset protection trust. An asset protection trust is a vehicle that holds your assets (including real estate) and effectively shields them from the nursing home and other creditors. While it can help you qualify for Medicaid should you need it, it’s not something that can be hastily put together. It requires forethought. Remember, the five-year lookback period still applies.  

When an asset protection trust is formed, you appoint a trustee to manage the assets for you. Relatives and adult children are often utilized as trustees. After your passing, any assets that remain in the trust after settling debts will go to your beneficiaries. From a gifting perspective, an asset protection trust offers the advantage of helping your heirs avoid probate, saving them time and money. 

An asset protection trust may enable you to ensure that a surviving spouse is cared for, or that you’re able to financially support loved ones after you’re gone without putting you at risk of losing everything to a nursing home while you’re still alive. That said, this is just one type of trust, and certainly not a one-size-fits-all solution. When it comes to gifting and planning for long-term care, the best strategy for your circumstance is the one you develop with a caring elder care or estate planning attorney. If you’re looking for someone with heart who can help you and your family, set up a complimentary consultation with one of our attorneys today.