Taxation of Gifts: The Basics
We often get inquiries from our clients about how much they can give to their loved ones without incurring tax consequences.
The good news is few Americans will ever have to worry about the federal gift tax. The reason is simple: Federal gift taxes are owed only on very large gifts you make. The lifetime exemption for 2016 is $5,450,000. This exemption is inflation indexed and typically increases each year. The exemption means until your collective gifts reach these dollar amounts, you don’t have to worry about paying the federal gift tax. For gifts over the exemption amount, the tax on these excess gifts is currently 40%.
Note, however, that there is a separate duty to report to called “taxable gifts”, i.e., gifts that exceed $14,000 per year per person. You satisfy that duty by filing a gift tax return (IRS Form 709) when you file your annual income tax returns. Although you report the amount of the gift, you do not incur gift tax liability, i.e. a duty to pay taxes, until you have used up your lifetime exemption which, as noted above, is over $5 million. You do not have to report to the IRS any gifts that are under $14,000 per person per year.
Still, it’s always a good idea to understand the dynamics and be prepared, even if the federal gift tax doesn’t seem relevant today. Understanding what federal gift taxes are – and what they’re not – is always good information to know.
For the sake of the gift tax, a gift is defined as any transfer for which the giver receives nothing in return, or a transfer at less than fair market value. Fair market value is simply the price at which an asset would sell when there is both a willing and knowledgeable buyer and seller. The person who makes the taxable gift is responsible for filing the gift tax return and paying any taxes that are owed. For example, if you sell your car to your best friend for $10 and its fair market value is $5,000, you are responsible for the tax implications on the $4,990 gift.
So now that we know what constitutes a taxable gift, what type of gifts aren’t included?
- Any gifts less than the annual exclusion amount (currently at $14,000 per person to any individual)
- Tuition paid directly to the educational institution. Note: this does not include books, supplies, apartments or other living expenses
- Medical expenses paid directly to a doctor, hospital, or other medical entity
- Gifts to your spouse (if your spouse is a U.S. citizen)
- Political donations
- Charitable donations
