While it may seem counterintuitive, market downturns can be a great time to give more to your family members and other individuals, assuming you have the desire and means to do so. Essentially, in a declining market, you can give more than you could at the top of the market without increasing your tax liabilities.
In particular, consider meeting or even exceeding the annual gift tax exclusion, which is the amount you can gift tax-free each year. With current market variability, now could be a good time to give assets that have dropped in value since your recipients can potentially enjoy an increase in value once the market recovers.
Understanding the Annual Gift Tax Exclusion
The annual gift tax exclusion serves the role of preventing people from maneuvering around estate tax rules, such as with parents who give most of their assets to children while still alive. With the exclusion, you are allowed to give away assets up to a certain value each year tax-free.
These gifts can be in a variety of forms, such as cash, homes, and stocks. Non-cash gifts are assessed at their fair market value.
As an individual, your gift tax exclusion for 2020 is $15,000 to each of your recipients. If you are gifting as a couple, you can give $30,000 tax-free to each of your children, for example. And if those children are married, you can give $60,000 per couple, or $30,000 to your child and $30,000 to their spouse.
However, exceeding the annual gift tax exclusion doesn’t necessarily mean you will owe taxes (although you will have to file IRS Form 709 to report the gift). You also have a lifetime gift tax exemption to work with. Anytime you exceed the annual exclusion, you can use the excess amount against your lifetime gift tax exemption, which reduces your lifetime exemption amount. If you exceed the lifetime limit, then you will owe taxes.
Currently, the lifetime gift tax exemption is $11.58 million for individuals and $23.16 million for couples; however, don’t assume that the exemption will always be so high. It is already set to drop to $5 million in 2026. Many people believe taxes will likely increase to address this country’s debt—in which case, the lifetime gift tax exemption may be decreased, and the top tax gift rate increased.
In 2010, the lifetime gift tax exemption was a lot less: $1 million. This is a number that may be easier to imagine leaving to your children. So, while this gifting strategy may not seem to apply to you now, potential tax changes can make it worth considering today.
How a Market Downturn Can Help You Give More
Since you can exceed the annual exclusion without having to pay taxes if you stay within your lifetime limits, a market downturn can be an optimal time to leverage estate and tax strategies.
For example, assume the COVID-19 pandemic’s impact on the economy and the market forces home values to fall. You decide to buy a condo and gift it to your child. Suppose the condo you purchase for $250,000 had been listed for $300,000 in previous months.
This means you are essentially gifting a “better” condo that you could otherwise buy with $250,000 a few months prior. Over time, the housing market will likely recover, and your child will enjoy an increase in the condo’s value.
Similarly, you can gift assets such as mutual fund shares. Suppose you want to give 500 shares of a mutual fund that were worth $50,000 a few months ago. With the recent market volatility, the shares might be worth $40,000 now.
This means only $40,000 will count toward your lifetime gift tax exemption. Meanwhile, if your gift recipient holds on to the shares as part of their long-term investment strategy, the value can climb as the market recovers.
Keep Estate Taxes in Mind
While you can essentially gift more during a down market, you still need to keep estate taxes in mind. When you apply any amount to your lifetime gift tax exemption, that amount reduces the total. For example, if you gift property worth $1 million more than your annual gift tax exemption, then your estate tax will begin at $10.58 million as an individual, rather than $11.58 million.
You might feel that $11.58 million is a number so high that you’ll never have to worry about exceeding it. It is important to note again that changes to the tax law could reduce it to a number that does affect you and your heirs.
Consider talking to a fiduciary financial advisor or estate planning attorney to determine whether gifting to your heirs now is more beneficial than waiting to bequeath the assets after you pass. A financial advisor will consider your gifting wishes as part of your long-term financial plans and needs.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
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