The federal gift tax is one of the most misunderstood and often ignored taxes assessed by the federal government. Our clients are always asking us about gift taxes and it is time to clear up the mystery and review all of the components of this tax.
What is the Definition of the Gift Tax?
The gift tax is a tax assessed on the value of property that is gifted from one person to someone other than their spouse (provided that the spouse is a U.S. citizen). In other words, if jewelry, stocks, real estate or any other type of property is given to a friend or to a family member, other than your spouse, for less than full fair market value of the property, a gift has been made that may be subject to federal gift tax laws. A gift tax may also be incurred if you add someone to your bank or investment account or to the deed for your real estate, so it is important to discuss these decisions with your advisor prior to taking action. This tax also applies to gifts of cash. It sounds alarming, but keep reading to find out why most people will not have to pay federal gift taxes.
Which Gifts Are Excluded?
Some gifts are excluded from the gift tax entirely. You can gift any of the following without incurring a gift tax:
- Gifts to your spouse,
- Gifts to a qualifying charity,
- Gifts to a political organization for its use, and
- Payments made directly to an educational institution or health care provider to pay for someone else’s tuition or medical expenses.
Annual Gift Tax Exclusion
Even if gifts do not fall under the above exclusions, you can still give up to $14,000 this year without the gift being taxable through the annual gift tax exclusion rules. The annual exclusion is per donor and per recipient. In other words, you can give up to $14,000 per year to as many different people as you like, without exceeding the annual exclusion and without owing any taxes or filing any paperwork with the IRS. If you are married, your spouse can also give up to $14,000 to each of those same people without exceeding the annual exclusion.
So what happens once the annual exclusion amount is exceeded? Gifts above the annual exclusion amount require the taxpayer to file Form 709 to report the taxable gift. However, in most cases gift tax still will not be owed. After exhausting the annual exclusion, you then have to exhaust your lifetime exclusion before you actually have to pay any gift tax. For example, if you give $50,000 to your sibling in 2015, you will have made a taxable gift of $36,000 (that is, $50,000 minus the $14,000 annual exclusion). This $36,000 amount will count against your lifetime exclusion, and no taxes will be due. As of 2015, the lifetime exclusion is $5.43 million (and twice that for married couples). As you might imagine, most people never have to pay any gift tax, because they do not come close to exceeding their lifetime exclusion.
The lifetime exclusion is a shared exclusion with the estate tax. The overall purpose of the gift tax is to eliminate the possibility of people simply gifting assets to their heirs before they die in order to avoid the estate tax. When it is explained in this manner, it is easy to see that a shared exclusion makes sense. By making a taxable gift, you reduce the amount that can be left to your heirs before the estate tax kicks in.