One of the most, if not the most, confusing taxes that people encounter in their lifetime is the Internal Revenue Service’s gift tax. The whole concept sometimes makes people contract vertigo if they’ve never had it before. That is, ”Wait a minute! I give money away, and then I have to pay tax on that money?” The answer to that question is, “Well, yes. But not all the time.”
History of the Gift Tax
The gift tax came into being because of the estate tax. When the estate tax was promulgated, many clever people decided: “If I give my money away while I’m alive, then I don’t have to pay estate tax when I die.” Great plan, but sometimes the IRS is more clever than we think. They enacted the gift tax which says: If you give money away in your lifetime, you may have to pay tax on that money, because you would not be paying estate taxes on it.
Definition of a “Gift”
A gift is anything given away for less than fair market value. In other words, if I give a house away to my child for nothing, that is a gift. Many people try to get around it by saying, “I’ll just sell it to him for $5 and then it’s not a gift.” Another great plan, but that’s why I said anything given for less than fair market value. You can receive consideration for something you give away, but it still may be a gift, if the consideration is not fair market value.
There are many exclusions to the gift tax, however, so let’s talk about what they are.
The current annual exclusion for gifts is $14,000 per donee. Look at that word again: “donee”. Not per donor. So, if I had $14 billion, I could give that money away to 1 million different people and not pay any tax. I would not even have to file a return. You do not have to file gift tax returns if the only amounts you give away during the year are covered by the annual exclusion. For instance, if my spouse and I want to give money to my son and his spouse, we can give them up to $56,000, because I can give $14,000 to each of them, as can my wife.
Another exclusion is the marital exclusion. I can give as many gifts as I want to my spouse, and vice versa.
If you pay someone’s medical expenses or tuition, directly to the providers, there is no gift tax. If you gift an amount of money to a person so that they can pay their tuition, you will be subject to a gift tax.
Besides the annual exclusion, there is a lifetime exclusion, which is currently $5,340,000 – which, coincidentally, is the exact amount of the exclusion for estate tax purposes.
- I can give away $14,000 to any individual I want, and I will not have to pay taxes. In fact, I don’t even have to file a return.
- If I give away $15,000 to one person other than my spouse, I would have to file a gift tax return. I would not have to pay a gift tax, however, because $14,000 of my gift doesn’t count. The extra $1,000 gets reported to the government as a gift that I made, but I don’t pay tax on that because I can subtract that from my lifetime exclusion of $5,340,000.
- If I were to die in the next year, my estate tax exclusion, which would normally be $5,340,000, would now be $5,339,000, because I had used $1,000 during my lifetime.
Most of us will never have to pay gift taxes, because not only are we entitled to the annual exclusion, but we are also entitled to the lifetime exclusion.
Next time, we will delve a little further into the estate tax, and how that affects individuals. If you have any questions, feel free to contact your tax adviser, or you can contact me.