As discussed above, each taxpayer is entitled to give away one unified lifetime exemption amount whether during life or at death. This amount is distinct from the so-called “annual exclusion,” a separate right to gift assets up to a certain dollar amount each year to as many people as one wishes. Like the unified lifetime exemption, the annual exclusion amount is adjusted annually to account for inflation. For both 2019 and 2020, the annual exclusion amount is $15,000. Annual exclusion gifts need not be cash; the limit is $15,000 of value regardless of the kind of property the donor gives away.
There are also two types of unlimited gift exclusions: certain tuition payments and certain medical payments. It is critical to note that both types of gifts must be made through direct payments to the applicable educational institution or medical service provider. For example, a grandfather would not be able to exclude the $30,000 he pays for his granddaughter’s college tuition if he makes the check out to his granddaughter rather than directly to her university. Tuition payments are defined narrowly. Though this exception has been extended to cover the entire educational process from kindergarten to graduate school (as well as many vocational programs), the exception generally does not apply to the costs of books, lodging, and other education-related expenses. On the other hand, the definition of medical payments is quite broad; it encompasses a range from doctor visit fees to long-term care costs to health insurance premiums. One major category of medical expenses not eligible for the exclusion is payments made for purely cosmetic plastic surgery.
Here is an example involving both unlimited exclusions, the annual exclusion, and the unified lifetime exemption, assuming that Sally Supper has made no past gifts. In January 2020, Sally pays her nephew’s $10,000 fourth grade spring tuition directly to his private school and pays a $250 doctor bill directly to his pediatrician. In February 2020, she makes cash gifts of $15,000 each to her only daughter and a family friend. Finally, in March 2020, Sally gives her daughter Apple stock valued at $10,000,000 on the date of transfer.
None of these gifts would trigger gift tax for Sally. First, the direct payments of tuition and medical expense fall under unlimited exclusions. Second, both cash gifts are tax-free due to the annual exclusion of $15,000 per donee. Finally, Sally’s gift of Apple stock to her daughter would use $10,000,000 of Sally’s unified lifetime exemption amount, $11,580,000 in 2020. Upon Sally’s death in December 2020, Sally’s estate would be exempt from estate tax on the first $1,580,000 of remaining assets. Thereafter, a flat estate tax rate of 40% would apply.
An additional benefit applies to married couples. Such couples can take advantage of so-called ‘portability,’ by which the first spouse to die leaves any remaining unused exemption for the surviving spouse to use. The executor of the estate for the first-to-die spouse qualifies the surviving spouse for portability by checking a box on the timely filed estate tax return Form 706 for the first-to-die spouse. No further action is required.