Student Question of the Week: Sources of Gift Tax Liability

Student Question from Ryan F
Course:  Estate Planning

Student Question:

Hi Dan, 

I have a question about an estate planning concept.  I think I’m just reading it wrong, but I want to make sure I have a clear understanding.  What is the correct answer to this question, and why?

A husband and wife wish to reduce the size of their estate by making gifts to or for the benefit of their nephew, who is attending college where tuition is $25,000 per year. The largest amount they can transfer to or for the benefit of their nephew in 2013 without incurring gift tax liability and without using any of their Applicable Credit Amount is:

  • $25,000, plus cost for books, supplies, and fees
  • $25,000
  • $28,000
  • $53,000
  • $53,000, plus cost for books, supplies, and fees

Instructor Response:

Hi Ryan!

On this question, we’re being a little tricky.  You’ve obviously got the $25,000 in tuition if they transfer directly to the school.  On top of that, the husband and wife can each transfer $14,000.  So $25,000 tuition plus $28,000 in gifts is a total of $53,000.

Let me know if you have questions on this.

Student Response:

Wouldn’t using the $28k take away from their Applicable Credit Amount though?

Instructor Response:

Absolutely not.  Every single person is allowed to gift up to $14,000 per year, to as many people as they want, without any gift tax repercussions at all.  It is called the Annual Gift Tax Exclusion.  So, I can give $14,000 to you, another $14,000 to your mom, another $14,000 to your dad, another $14,000 to your brother, etc.  And all of those are completely free from any gift tax impact. It’s just like me handing you $5 in the street.

Now, once you exceed that $14,000, you have made what is called a taxable gift.  So if I give you $15,500, I have given you a “taxable” gift of $1,500.

Will I pay taxes on that $1,500?  Not if I have my lifetime Applicable Credit.  But I do have to record this $1,500 gift and file a gift tax return for the year.  It would zero out, and I wouldn’t have to pay anything, but now I’ve used $1,500 of my lifetime Applicable Credit.

Does that help to clarify?  Let me know.

Student Response:

Yes, that really clears things up. I thought even the first $14,000 exclusion amount applied to the lifetime Applicable Credit.  Thank you.