Untangling Two Gifting Rules
There are two gifting “rules” that are easily confused when individuals are planning to make gifts. The first rule is actually a law: the Federal Gift Tax Exemption. The second rule is a Medicaid regulation that is commonly referred to as the “Five-year Look-Back Rule.” This article will explain the mechanics of each rule and clarify who is impacted and under what circumstances.Information in this article is specific to the State of Tennessee. State laws vary regarding estate and gift taxes and regarding Medicaid law. Tennessee does not have a state gift tax (or an estate/inheritance tax), and state-specific rules guide Tennessee’s Medicaid program, CHOICES. This article also does not discuss capital gains taxes, which should be carefully considered when giving property to another person, particularly if that property is real estate.
Federal Gift Tax Rule
Federal gift and estate taxation is considered a unified tax: it is designed to prevent an extremely wealthy person from avoiding estate taxes at the time of their death simply by giving away their wealth during their lifetime. Financial gifts over a certain annual threshold are reported during annual tax filing season, and the estate of a very wealthy individual will only be taxed at the person’s time of death, for gifts reported during the person’s life, if certain conditions are met.Congress passes laws to create an annual Federal Gift Tax Exemption. This is the maximum amount one person can give away to another person without having to report the gift with their taxes. Like the Estate Tax Exemption, the Gift Tax Exemption is fairly high. For the year 2022, the Federal Gift Tax Exemption amount is $16,000 per person per recipient, and married people can collectively gift $32,000 per recipient without triggering the requirement to file a federal gift tax return. If an individual makes a gift to a recipient that exceeds that year’s gift tax exemption, the result is that the person making the gift must submit gift tax form 709 with the IRS when filing their taxes.Filing a gift tax return does not mean the person making the gift has to pay a tax. The IRS keeps a record of all gift tax returns submitted during the person’s lifetime. When that person dies, if their estate is larger than the federal estate exemption for the year in which they died (again, $12.06 million in 2022), then the IRS considers the gifts previously reported during the person’s lifetime when calculating the federal estate tax owed. Even if the gross value of the donor’s estate exceeds the exemption amount, only the amount over the exemption is taxed. If the estate is below the exemption amount, prior gifts are not taxed.As well as establishing the annual Federal Gift Tax Exception, Congress passes legislation to establish the annual Federal Estate Tax Exemption each year. The threshold for exemption has been raised over time, so this tax affects fewer and fewer taxpayers each year. The 2022 exemption is $12.06 million for an estate. Unless a person dies with well over $12.06 million in assets, they need not worry about estate taxes or gifting taxes. For most people, the only consequence of making gifts that exceed the annual gift exemption is the inconvenience and nominal cost of filing a gift tax return, and they never pay a tax.In summary: gift taxes only impact the exceptionally wealthy. For the few individuals affected, they are not paid until the time of the gift-giver’s death.
Medicaid Five-year Look-Back Rule
The Medicaid Five-year Look-Back Rule has nothing to do with taxes and everything to do with eligibility for Tennessee’s Medicaid program for long-term care of elders or individuals with disability. Tennessee’s long-term care Medicaid program is called CHOICES. This program helps cover the cost of long-term care at home or in a residential facility, such as an assisted living or nursing home. Because the cost of long-term care is so high (typically several thousand dollars per month), many people in Tennessee require this benefit to help cover the cost of care over several years. The average Tennessean is much more likely to be impacted by the Medicaid Five-year Look-Back Rule than the Federal Gift Tax Rule.When a person files an application for CHOICES benefits, they must report all gifts made in the sixty (60) months prior to the application date. For the purpose of the CHOICES application, a “gift” means any and all transfers of property (including non-liquid assets such as real estate) to another person for below fair market value. This five-year period prior to the application filing date is what is commonly referred to as the “look-back period.”Although making gifts may not have a negative tax consequence, gifting should be carefully considered if there is any possibility that the gift-giver might need nursing home or assisted living care in the five years after the gift is made. If a person is otherwise eligible for CHOICES benefits but that person made a gift during the look-back period, the recipient of the gift must either return the gift or the gift-giver will be ineligible for benefits for a period of time that is calculated based on the value of the gift. During the period of ineligibility, the person who needs long-term care will have to pay for that care out of pocket or may have to seek the help of family members to meet their needs.In summary: the Medicaid Five-year Look-Back Rule impacts many ordinary Tennesseans and should be considered before an elder or other person approaching long-term care gives away any money or other assets.
Questions About Gift Giving
If you or a loved one has questions about the consequences of making gifts, seek professional help to get your answers in advance. Proper planning can help you apply these gifting rules to the appropriate situation. A qualified professional may be able to help you achieve your end goals while avoiding negative consequences of gift giving.
