It is quite common for families to want to leave a legacy to their children and grandchildren, or during their retirement years, to even provide large gifts to their children and grandchildren. However, when you leave these large gifts to your children and grandchildren, you could unknowingly be subjecting your children and grandchildren to long-term potential tax implications. In addition, these large gifts can result in potential estate tax implications.
The most important tax consideration is to discuss and weigh the differences between step-up in basis and carry over basis in regards to a large gift made to you children or grandchildren. For instance, when you pass an asset to one of your heirs at death there is what is called a step-up in basis. This means that the tax basis of the asset is what the asset is worth at the date of death and when the asset was passed to the heir. For example, if you bought 1000 shares of Microsoft stock for $20,000.00 in 1990, and it was worth $200,000 when you died in 2020, then the tax basis of the Microsoft stock inherited by your child or grandchild would be $200,000. Therefore, if the child or grandchild that inherited the stock turned around and sold it immediately for $200,000.00, the sale would not be subject to the capital gains tax as the tax basis for your child or grandchild when he or she inherited the stock would be $200,000 and not $20,000. Meaning, that your child or grandchild did not realize a gain on the sale.
However, the tax basis is very different if you donate the asset to your child or grandchild during your lifetime. When you donate or give away an asset during your lifetime, it has what is called carry over tax basis. Therefore, the child or grandchild that you give the asset to you during your lifetime has the tax basis of what you had when you originally acquired the asset. For example, and using the facts above, if instead of leaving the asset to your child or grandchild at your death, you instead decide to give the Microsoft stock to your child or grandchild during your lifetime. If you decided to give the Microsoft stock as a gift during your lifetime, then your child or grandchild would have a tax basis of $20,000 and not $200,000. Therefore, if your child or grandchild turned around and immediately sold the Microsoft stock, your child or grandchild would have a capital gains tax obligation to the IRS on the $180,000 gain (the difference between the sale price of $200,000 and the original basis of $20,000 when the asset was acquired).
In addition, you should also note that anytime you make a large gift during your lifetime over $14,000.00, this has to be reported on a gift tax return filing at the end of the tax year in which you made the gift. Also, the amount above $14,000 that you gave away to your child and/or grandchild would reduce your life-time estate tax exemption. For example, you have an exemption from the federal estate tax in the amount of $5,250,000. This means that your first $5,250,000 in assets that you pass to your family at your death is exempt from the federal estate tax. However, if you gifted your $20,000 in Microsoft stock to your child during your lifetime, as in the example above, then your $5,250,000 estate tax exemption would be reduced to $5,230,000 exemption at death. As such, when you died, you would only have a $5.23 million exemption instead of a $5.25 million exemption from the federal estate tax. However, less than 1% are likely to be subject to the federal estate tax under the current federal tax laws. However, making too many large gifts over a lifetime could result in depleting your federal estate tax exemption and your estate owing estate tax at your death. Therefore, it is important to pay close attention to large gifts and the potential long-term estate tax implications.
For these reasons, it is very important that you understand the tax obligations for both yourself and the person that you are making the large gift to. Therefore, you should always speak with an estate planning attorney before making any large gift to determine the best approach from an estate planning and tax planning perspective.