Gifting and the Gift Tax

It’s easy to get confused by the differences between gift tax, estate tax, income tax and capital gains tax and where and when any or all of these different taxes apply at both the federal and state level.

A gift is “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return” and may be taxable under specific circumstances.

Very few people ever need to pay federal gift tax, but when taxable, the gift tax is the responsibility of the person who gives a gift (i.e. the donor), and the amount of any tax due is based on the value of their gift. The person who receives a gift (i.e. the donee) is generally not responsible for paying the gift tax. However, if the donor does not pay the gift tax, the donee may have to pay the tax instead.

Here are a few things you should know about the Federal gift tax:

1. Gifts to Family Members Count

The gift tax and exclusion limit (below) apply whether you are making the gift to a complete stranger, a nephew, or your own parents or children. The only person you can give a gift to that is exempt from the gift tax is your spouse. Gifts to your spouse qualify as a “marital deduction” for federal gift tax purposes and so are not taxable.

2. There Is an Annual Gift Tax Exclusion

You do not have to pay tax on gifts that are less than the annual exclusion limit, which can change from year to year, but tends only to go up over time.  Currently, the annual exclusion is $14,000 per recipient.  In other words, you can give up to $14,000 to each of your children this year without having to pay any gift tax.

Together, a married couple can give $28,000 to each donee without incurring the gift tax.

3. There Are Also Educational and Medical Exclusions

Payments that you make on someone’s behalf for qualified tuition or medical expenses do not count towards the annual limit for gift tax purposes. However, your payment(s) must be made directly to a qualifying educational organization or medical care provider in order to qualify for the exclusion.

4. You May Need to File a Gift Tax Return (Form 709)

In general, you must file a Federal gift tax return (IRS Form 709) if you gave someone more than $14,000 during the year. Form 709 is an annual return that is due by April 15 of the year after the gift was made. In the case of a couple, each spouse has to file their own, separate return.

5. Each Donor Has a Lifetime Exemption

If your gift exceeds the $14,000 annual threshold, it must be reported as a taxable gift on Form 709 — however, that doesn’t necessarily mean you’ll have to pay the gift tax. Instead, you can apply the gift towards your lifetime exclusion from the Federal estate tax.

The “basic exclusion” (also known as the “unified credit”) represents both the lifetime gift tax exemption and the estate tax exclusion, which is $5,490,000.00 for 2017. The current law allows individuals to give away up to $5.49 million over their lifetime (or almost $11 million per couple – see “DSUE” below) without having to pay gift any tax. Under current law, the estate tax exclusion is also indexed for inflation and so the amount you can give away over your lifetime is growing every year.

Any portion of your lifetime exemption that’s used to offset gift tax will reduce the amount that will ultimately be exempt from estate tax. For example, if you used $2 million of the exemption to make taxable gifts during your lifetime, then you will only be able to exclude $3.49 million from federal estate tax.

If you give away more than the $5.49 million lifetime limit, then you (or your heirs) may have to pay up to 40% tax.  The actual tax rate depends on how far your estate exceeds your estate tax exclusion ($5.49 million minus any taxable gifts) and the rate ranges from 18% at the low end  to 40% as the highest rate.

Also, for married couples, if one spouse dies and has not used their own $5.49 million exemption, then the surviving spouse can inherit the deceased spouse’s unused exemption (“DSUE”) and combine it with their own exemption. This allows a married couple to either gift or protect up to $11 million from estate and gift tax.  This option, also known as “portability” is not automatic, however, and must be “elected” on the estate tax return of the first spouse to die – even when no tax is due.

6. Most states do not have a state gift

Almost all states do not have a state gift tax. Currently, only Connecticut and Minnesota impose a state gift tax with certain exemptions that you should consider if you live in either state.

In conclusion, very few people ever need to pay federal gift tax.  You can always give someone up to the annual exclusion amount ($14,000 this year) and it won’t affect your lifetime exemption (because gifts below the annual threshold are not considered taxable).  If you exceed the $14,000 annual gift tax threshold, then you must file Form 709, but no tax is due until the total of all of your lifetime gifts exceeds $5.49 million.  Also if this is the case, then you should retain any filed gift tax returns so your heirs can keep track of your ‘taxable gifts’ as they will count against your lifetime estate tax exclusion.

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