Reviewing Gift Tax Laws

It’s income tax time again, so taxes are on everyone’s mind.  As an elder law attorney, the one question or comment that I hear the most has to do with gift taxes.  The federal gift tax engenders more misconceptions than any other issue of which I am presented.

Notice that I say federal gift tax.  There is no state gift tax of which I am aware.  Certainly, New Jersey does not impose a gift tax.  To my knowledge, only the federal government imposes a gift tax.

Most people who mention gift tax to me believe that there is some amount of money that they can gift in any one year without triggering a gift tax–$10,000, $11,000, $14,000.  People get those figures from a concept known as the annual gift tax exclusion.

The annual gift tax exclusion amount is indexed for inflation.  When I first started practicing, the annual gift tax exclusion was $10,000.  The amount—indexed for inflation—has increased to its current level of $14,000.

Most people tend to believe that if they gift more than $14,000 in any one year, they—or the recipient of the gift—will pay a tax, a gift tax.  But knowing the annual exclusion amount is really only part of the story, the small part actually.

The full rule would be as follows:  A person can gift the annual exclusion amount (currently $14,000) every year to an unlimited number of people without reducing his lifetime exclusion against gift tax.  It is the lifetime exclusion amount that makes gift tax irrelevant for almost all taxpayers.

A person’s lifetime exclusion amount is currently $5,490,000, a figure that is also indexed for inflation.  So, putting it altogether, a person can gift $14,000 a year to an unlimited number of people without reducing his $5,490,000 lifetime exclusion against gift tax.

In short, unless you have more than $5,490,000 in assets—and very few people do—you do not have to worry about gift tax.  A married couple can essentially double these credit amounts.  A married couple could gift $28,000 a year to an unlimited number of people without reducing their $10,980,000 lifetime credit against gift tax.  Very, very few people have that much money.

What then is this $14,000 all about?  Assume that Mr. Smith gifted $14,000 in a given year to 200 of his closest friends.  Assume further that Mr. Smith gifted $15,000 to one of his friends—perhaps just to show he liked him a bit more than the others.  Since Mr. Smith gifted $1,000 more than $14,000 to one person, Mr. Smith’s lifetime exclusion amount of $5,490,000 would be reduced to $5,489,000.

If Mr. Smith did, over the course of his lifetime, gift more than $5,490,000 taking into consideration his $14,000 annual exclusion amounts, then Mr. Smith, not the recipient of the gift(s), would pay gift tax.  A gift tax return—which is separate and apart from an income tax return—must be filed if Mr. Smith gifts more than $14,000 in any given year; however, unless he exceeds the lifetime credit amount, then there is no gift tax owed.

The recipient of a gift never pays gift tax.  The receipt of a gift is tax-free.

Now, there is another issue with gifting assts.  If Mr. Smith gifts his son stock that Mr. Smith has owned for years, then Mr. Smith’s son will receive Mr. Smith’s basis in the stock.  This means that if Mr. Smith purchased the stock for $1.00 and the stock is worth $10.00 today, then the son will have a basis of $1.00.  When the son sells the stock, the son will have to pay income tax on the $9.00 of gain.

If Mr. Smith died owning the stock, then the son would have received a basis step-up, meaning that the son’s basis in the stock would step up to $10.00.  When the son sells the stock, the son would not realize any gain and would not have to pay income tax on the sale of the stock.

Beware Non-Attorney Medicaid Advisors

The New Jersey Division of Consumer Affairs has issued a bulletin advising New Jersey residents of a potential for abuse by non-attorney Medicaid advisors. Medicaid is a health payment plan for needy individuals.

In order to qualify for Medicaid, an individual must have limited assets and income that is insufficient to pay for his care.  Once qualified, Medicaid will pay for many of the costs associated with long-term care.

The cost of long-term care can be significant.  For instance, a nursing home can cost anywhere from $10,000 to $14,000 per month.  An assisted living residence can cost anywhere from $4,000 to $10,000 a month, with the mean being somewhere around $7,000.  A live-in home health aide can cost anywhere from $3,500 to $6,000 per month.

With costs such as these, it is no wonder that a great many people seek professional assistance in order to qualify for Medicaid benefits.  Once qualified, Medicaid may be for many of the aforementioned costs or, at least, assist with the payment of those costs.

Qualifying for Medicaid is no simple process.  Even an individual who is truly impoverished can have legal issues for which he would benefit from competent professional advice.  An individual with assets who is seeking to preserve a portion of his assets most certainly would require the assistance of an attorney in order to accomplish his goals of asset preservation and qualification for benefits.  This process of asset preservation and qualification for Medicaid is called Medicaid planning.

Elder law attorneys are frequently the attorneys who assist clients with Medicaid planning.  As an elder law attorney, I have assisted hundreds of people in qualifying for Medicaid.

Medicaid planning involves advising clients as to how to shelter their assets through direct gifts to family members or gifts to trusts.  An elder law attorney may also give advice regarding the drafting of a last will and testament, spending down assets, and converting countable assets to non-countable assets.

There are, however, non-attorneys who assist people in qualifying for Medicaid.  The Supreme Court of New Jersey has issued an opinion holding that providing Medicaid planning advice is the practice of law.  When a non-attorney is engaged to provide these types of services, the non-attorney is engaging in the unauthorized practice of law, which is a crime.

Now the New Jersey Division of Consumer Affairs has issued a bulletin warning the public about these practices by non-attorney Medicaid advisors.  The problem is, families are often referred to non-attorney Medicaid advisors by someone they believe to be knowledgeable about the Medicaid program.  For instance, a staff member of a nursing home might refer the family to the non-attorney Medicaid advisor.

As far as the family is concerned, they are doing the right thing; they are using the organization to which the nursing home where their mom resides referred them.  In reality, though, the family is being referred to a non-attorney who cannot, by law, engage in the work they are performing and who is providing inferior advice and counsel to the family.

Ironically, these non-attorney Medicaid advisors often charge the family what an attorney would have charged.  I have met several family members who have consulted with non-attorney Medicaid advisors, and I know the fees these non-attorneys have quoted my clients.  Their fees are often the same as my fee or, sometimes, more than my fee.

Family members who engage the services of a non-attorney Medicaid advisor are often getting inferior services at a high cost, both in fees and in lost opportunities.  So, beware, if the person giving you advice about Medicaid planning isn’t an attorney, then that person is committing a crime and probably is giving you bad advice.

Planning with IRAs

As the Baby Boomer generation ages, more estate plans need to incorporate language that accommodates qualified retirement accounts, such as individual retirement accounts and 401(k) plans.  Qualified accounts are tax deferred accounts, meaning that taxes are deferred until the owner or the designated beneficiary of the account removes the money from the account.

Because the government eventually wants to receive the tax that it permits people to defer through a qualified retirement account, the rules governing these accounts require that the owner of the account and the beneficiary of the account after the owner dies remove money from the account over a specified period of time.

Every year, the owner or beneficiary must tax the required minimum distribution amount. This is the minimal amount of assets that the owner must remove every year.  The amount is recalculated every year based upon the owner’s age and life expectancy tables.  The younger an owner (or beneficiary) is, the longer the period of time over which the owner can remove the money from the qualified account.

An owner could remove all the money from the account in any given year; however, the owner must remove the required minimum distribution amount each year.

Sometimes, a person will come to me and tell me that he wants to establish a “stretch IRA.”  A stretch IRA is a concept, not a type of retirement account.

By naming a designated beneficiary of a young age, the beneficiary can stretch out the time during which there is money left in the IRA on which the beneficiary is not paying income tax.  For instance, if a beneficiary must remove money from the IRA over his life expectancy, then an eight-nine year old beneficiary is going to have to remove the money quicker (and in larger amounts) than a beneficiary who is ten years old.  A ten year old is expected to live much longer than an eighty-nine year old; therefore, the law permits the ten year old to remove the money much more slowly than an eighty-nine year old.

And the longer the money remains in the IRA, the longer income taxes are deferred on the money.  When a beneficiary removes money from the IRA, he must claim the amount removed as taxable income in the year in which he removes the money.

People who were born in the 1920’s and 1930’s tend to not have very much money in qualified accounts.  People who were born during these decades simply didn’t work when qualified accounts existed.  They tend to have defined pension plans, plans from their companies that pay them a fixed amount of money every month.

People who were born in the 1940’s and later tend to have more money in qualified accounts.  So as these people age and begin to plan their estates, they will need to take into consideration their retirement accounts.

If you wish to leave a portion of your estate to a person who is a minor, how do you efficiently do this? In most instances, when you leave money to a minor, you leave it to them in a trust.  A trustee is appointed to hold and administer the money for the minor until the minor attains a certain age, such as twenty-five.

With an IRA, you need to ensure that the trust qualifies as a designated beneficiary.  If the trust fails to meet the requirements to be a qualified beneficiary, then the money might have to come out of the IRA much more quickly, which could cause negative income tax consequences for the minor beneficiary.  The Internal Revenue Service has rules that a trust must satisfy in order to be a designated beneficiary—the trust must be irrevocable, valid under state law, the trust beneficiaries must be identifiable people, and a copy of the trust must be provided to the custodian of the IRA.  A failure to meet any of these rules could result in significant income tax consequences to the beneficiary.