Waiting until year-end 2023 to use your gift tax exclusion is not simply unnecessary; it may be less efficient.
Year-end is a busy time for tax planning. It brings a sense of urgency, and for many tax-related transactions, it brings the necessary clarity to estimate one’s overall tax liability for the year. However, in the case of annual gifting, acting earlier in the year is often more advantageous.
This is true for two primary reasons. First, if you gift an asset with appreciation potential, such as stock or investment real estate, to an individual or trust, you are able to remove the appreciation and income from your tax base for the year of the gift as well as the following years. Second, by making the gift early in the year, you allow the recipient to benefit from the potential growth of the gift throughout the remainder of the year and beyond.
The Advantage of Early Gifting
Consider, for example, gifts made in January compared to gifts made in December, assuming:
- The current 2023 gift tax exclusion amount of $34,000 per married couple per recipient ($17,000 per individual per recipient)
- 10 years of gifting
- 5% annual pre-tax return
- Year-end gifts are made on December 31 and early-year gifts are made on January 1
Important considerations for early gifting
While gifting appreciating assets is often mutually beneficial for both the donor and beneficiary, you will want to carefully weigh the pros and cons with your advisors. Most importantly, you will want to consider the beneficiary’s tax liability; the benefit to you of annual tax free gifts comes at the cost of the recipient receiving the asset with your cost basis. For bequests at death, on the other hand, beneficiaries receive assets with a fair market value cost basis.
It is also important to note that making annual exclusion gifts is most advantageous for individuals and married couples who expect to have a taxable estate for federal or state estate tax purposes. With the passage of the Tax Cuts and Jobs Act, this pool shrank considerably – at least temporarily – as the federal lifetime gift tax exemption amount more than doubled. That said, the current higher exclusion amount (in 2023, $12.92 million per individual and $25.84 million per couple) will sunset on December 31, 2025 and could be lowered beforehand depending on changes in tax policy.
Potential advantages of early retirement and college savings plan contributions
Annual gifts are not the only planning that might make sense early in the year. You may also benefit by funding your retirement accounts and any college savings plans early in the year, every year. However, consult with your trusted tax and financial advisors first, as each individual’s and family’s financial and tax circumstances are unique.
Other tax planning opportunities
While some planning techniques make sense earlier in the year and others later, mitigating your tax burden and optimally transferring wealth have no “season.” For additional tax planning ideas in the context of the current macro landscape, read Preparing For Change: Year-End Planning.
Financial Education Opportunities for Your Children
In addition to maximizing the benefits of their financial gifts, many parents and grandparents also wish to equip their children to manage them responsibly. Financial education is one of the best ways to achieve this goal. To help, talk to your advisors about where to find age-appropriate resources, and learn more about Northern Trust’s Essentials financial literacy curriculum designed for young adults.