Gifting to save taxes | Fendrick Morgan

Gifting Considerations: More Than Just Altruism

As practitioners in both traditional estate planning and asset protection, we frequently talk to clients about gifting. However, one size does not fit all when it comes to gifting. It is important to understand how gifts are treated differently depending on a client’s specific circumstance and goals.

From an estate planning perspective, the two most common reasons for gifting (besides altruistic reasons, of course) are for saving taxes and for qualifying for public benefits, such as Medicaid.

1. Gifting to Save Taxes

In the estate planning world, gifting to save taxes is focused on getting assets out of your name so they are not includable in your estate at the time of your death for the calculation of any federal or state death tax that may apply. However, federal and state jurisdictions treat gifts made during your lifetime differently and these differences must be considered when determining if gifting is advantageous in your specific situation.

The federal government currently has a unified gift and estate tax exemption that changes on an annual basis. For 2022, the unified exemption amount is $12,060,000 for 2022. This means that any gifts made during your lifetime (with the exception of the annual gift tax exclusion amount, discuss below) will be added to your taxable estate at the time of your death and, to the extent that combined amount exceeds the exemption amount in the year of your death, your estate will owe federal estate tax.

The federal government’s gift tax laws include an annual exclusion amount. For 2022, the annual gift tax exclusion amount is $16,000. In 2022, any individual can gift $16,000 to as many different people as he or she wishes and such gifts will not be clawed back in at the gifter’s death for calculation of his or her total taxable estate for federal estate tax purposes. Making annual gifts up to the federal gift tax exclusion amount to each of your children, grandchildren, etc. has historically been an easy and common strategy to attempt to lower your taxable estate. However, given that the federal gift and estate tax exemption amount is currently so high, making gifts of only the exclusion amount each year is unlikely to make a significant difference in a high-net-worth individual’s taxable estate.

The State of New Jersey and the Commonwealth of Pennsylvania both treat gifts made during lifetime in a different way than the federal government. Both states currently have an inheritance tax that may apply at the death of a resident of that state (or a non-resident who owns real property that state). Whether the inheritance tax is applicable in both states depends on the relationship between a decedent and his or her beneficiaries. (See our separate blog post on the specifics of the New Jersey inheritance tax, including the different tax rates, from October 2021.) For inheritance tax purposes at a person’s death, both New Jersey and Pennsylvania claw back in any gifts made within a certain number of years before the decedent’s death. The State of New Jersey includes any gifts made within three years of the date of death and the Commonwealth of Pennsylvania includes any gifts made within one year of the date of death.

If a gift made within that applicable three-year period (for NJ) or one-year period (for PA) would have triggered inheritance tax had it been made at death, it must be reported on such state’s Inheritance Tax Return and any applicable inheritance tax must be paid. Any gifts made by an individual during his or her lifetime before the three-year period (for NJ) and the one-year period (for PA) preceding death are not includable for inheritance tax purposes at the gifter’s death. Notably, Pennsylvania does have a gift exclusion of $3,000 per person, so if any gifts made within one year of death do not exceed $3,000 per person, no Pennsylvania inheritance tax will be due on such gifts. New Jersey does not have a gift exclusion amount.

2. Gifting to Qualify for Public Benefits

In the asset protection realm, gifting is focused on getting assets out of your name in a timely manner in order to potentially qualify for resource-based public benefits at some point in the future. The important consideration when gifting to qualify for public benefits is that most government programs (most notably, Medicaid) have a look-back period. For purposes of this article, we will focus on Medicaid, which has a five-year look-back period.

Any gifts made during the five-year look-back period for Medicaid will result in a penalty, during which time Medicaid will not cover the cost of your medical care even though you are otherwise eligible. The penalty that is imposed is based on the amount of funds gifted during the five-year look-back period and a “divisor” that is set by the state and changes on an annual basis. This penalty calculation results in a number of days (which could add up to months or even years) during which time Medicaid will not cover your care. During the penalty period, you are personally responsible for paying for all of your care. However, in order for the penalty to even begin, you must otherwise be eligible for Medicaid. This means that the penalty does not start until you are otherwise under the resource cap (currently $2,000). You can imagine, if a penalty is imposed and your assets are now below $2,000, there will likely be a significant problem with paying for your care until the end of the penalty period when Medicaid will take over.

A common misconception is that Medicaid does not penalize gifts made during the five-year look-back period if such amounts do not exceed the federal gift tax annual exclusion (currently $16,000). This is not the case. Although such gifts would not trigger the need for filing a Federal Gift Tax Return, as discussed above, they would still result in a penalty for Medicaid-eligibility purposes. Medicaid presumes that any transfer of assets out of your name during the five-year period (even for small amounts) is a gift made in order to qualify for Medicaid. The person seeking Medicaid eligibility then has to rebut this presumption in order to avoid a penalty for that transfer, which can be difficult depending on the nature of the transfer and the substantiating documentation the person is able to provide.

If gifting is planned appropriately, in some cases an individual is able to take advantage of tax savings as well as removing assets from his or her name in order to qualify for public benefits. However, how these outcomes are achieved are highly dependent on an individual’s specific circumstances. If you would like to discuss how gifting may help in achieving your estate planning goals, please call our office at 856-489-8388 or visit our contact page to request an appointment.

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