The US federal gift tax applies to every gift you make in your lifetime. Sounds pretty straightforward albeit a bit daunting, right? Of course, there’s more to it than that.
The gift tax has a number of exclusions to be aware of. Trust us when we say, these exclusions are a good thing. Still, all the fine print can start to get a bit confusing and you may be wondering if this tax applies to you.
Let’s take a look at this largely misunderstood tax and put your confusion to rest. If you still have questions afterward, be sure to give Opsahl Dawson a call– we can help!
What Is the Federal Gift Tax
The gift tax is a 40% tax, created to regulate the value of gifts you give away. The primary purpose of this tax is to stop people from skirting Estate Tax by giving away all their money before death.
WHAT IS CONCIDERED A GIFT?
According to the IRS, a gift is considered “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”
If you give a gift and receive something back from the recipient, it’s considered a sale, not a gift. In this case, the income tax system may apply.
GIFTS TO FAMILY MEMBERS COUNT
The gift tax applies whether you are making a gift to a complete stranger, your niece, your parents or kids. The only exception to this rule is your spouse. In general, gifts to your spouse qualify for a marital deduction. There are a few stipulations:
- Your spouse must be a US Citizen
- Your spouse must have a “present interest” in the gift. Meaning, the gift is entirely for your spouse’s current use, enjoyment, and benefit, free from any strings attached. Learn more here.
EDUCATIONAL AND MEDICAL EXCLUSIONS
Not every gift is taxable. Payments you make on someone’s behalf for qualified tuition or medical expenses are not counted toward the gift tax. Certain rules still apply, though:
- Payments must be made directly to a qualifying educational organization or medical care provider.
- Funds may be placed directly into a 529 education savings plan, but certain rules apply.
- It’s always best to consult with your tax advisor before determining whether or not a gift is taxable.
If you’re starting to wonder if all those small monetary gifts you’ve made to your family and friends over the years are going to come back to bite you, you can relax. The IRS doesn’t punish all instances of generosity.
In fact, every US citizen is allowed a very sizable lifetime exemption from the gift tax.
This lifetime exemption also intersects with the annual gift tax exclusion. It’s very important to understand both of these gift tax exemptions.
Understanding the Gift Tax Exemptions
Like we mentioned at the beginning of this post, the federal gift tax applies to all gifts you make in your lifetime. However, every US citizen is allowed a lifetime exemption from paying the tax.
Lifetime Gift Tax Exemption
Under the lifetime gift tax exemption, your gifts are only taxed when their total value exceeds what you’re permitted to give away during the course of your entire life. As of 2017, the number you have to exceed is $5.49 million.
Annual Gift Tax Exclusion
There’s one more piece to this exemption puzzle– the annual gift tax exclusion.
This annual exclusion is the amount you can give away in any given year, totally free from any federal gift tax consequences. Currently (as of 2017), the annual gift tax exclusion is $14,000. You can give as many “freebie” gifts as you like, and to as many people as you want, so long as each gift amount does not exceed $14,000.
These gifts are not counted toward your $5.49 lifetime exemption. Only when you exceed the $14,000 exclusion threshold will the lifetime exemption kick in.
ANOTHER CAVEAT: COMBINED EXCLUSIONS
Married couples can each give up to $14,000 to the same recipient and stay within the annual exclusion amount. Meaning, together spouses can combine their annual exemption amounts and gift $28,000 per person, per year without incurring the gift tax.
If you and your spouse want to give a combined gift, we recommend giving the money in the form of 2 separate checks: one signed by you, the other signed by your spouse. This will help avoid confusion.
Even if you limit your combined gift to $28,000, you may still need to file a federal gift tax return. Consult with your accountant to ensure you’re properly following your tax filing requirements.
Reporting Gifts to the IRS
If you give a gift exceeding the $14,000 annual exclusion amount, you are required to report it to the IRS. In this case, you’ll need to complete and file a Gift Tax Return (Form 709). This form records your annual exclusion overage and is due on the 15th of the year following the year the gift was made.
At the end of your life, when your estate settles, all these overages are added together. If your overages exceed the current lifetime exclusion amount, you will be required to pay the gift tax. As we mentioned earlier, this tax currently sits at a whopping 40 percent.
A Gift Tax Example
Now that you have an overview of the gift tax, the gifts and individuals it applies to, and its exemptions, let’s review an example.
Let’s say a father makes a one-time gift of $34,000 to his daughter for the purchase of a car. $14,000 of the gift is free from the federal gift tax. The remaining $20,000 is a taxable gift and would be applied to his lifetime exemption.
But what if the father gifts his daughter $14,000 in November, and then gives her an additional $20,000 in January?
Remember, the annual gift exemption is per person, per year. So, the first gift of $14,000 would be free from the gift tax. Because the second gift of $20,000 was given under a new calendar year, only $6,000 of the gift will count against the father’s lifetime exclusion ($20,000 minus $14,000).
Still Have Questions about The Gift Tax?
There’s a reason people have questions about the federal gift tax– all those exclusions, exemptions, and other variables are confusing. There are a few resources we recommend you review to learn more:
It’s important to always consult a trusted CPA before making tax-related decisions. Here at Opsahl Dawson, our team of top professionals is dedicated to providing you with personal service all year long.
We would love to help answer your gift tax or other accounting questions. Give us a call!
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