Gifting and Taxes: Are Gifts Taxable?

Gifting money should not be complicated.  It seems to me that you should be able to give your money away to whomever you want, whenever you want, without anyone else’s involvement. The IRS does not necessarily agree. Suppose you want to give your child $50,000 toward the down payment on a house. You would probably expect a nice thank you note from your child, but you might also get a nice tax bill from the IRS. This is because you are only able to give away $14,000 per person, per year without incurring any gift taxes.

The fact that there is a potential tax on gifts may be your first surprise. The second surprise is the tax is assessed on the giver of the gift, not the recipient. Because there are many myths, misconceptions, and work-arounds to gift taxes, in today’s blog post, I will explain them as clearly and concisely as possible.

Income and capital gains taxes still apply:

The main reason people give gifts is generosity. A secondary reason is to reduce the taxes your heirs may pay when you die. The first thing to understand in this regard is that the only tax you might avoid by giving money away during your lifetime is estate taxes. Income taxes and capital gains taxes will still apply.

Understanding Estate Taxes:

The value of everything you own will need to be totaled up for your estate tax return, which is due nine months after your date of death. Many people are surprised to find out that the death benefits on their life insurance policies are considered part of their estates by the IRS. That seems sneaky of the IRS, if not downright unfair, but that’s just my opinion.

Nevertheless, you can leave all of your assets to your beneficiaries without paying any estate taxes as long as the value of your estate is below the federal estate tax exemption limit. Every dollar above the exemption will be taxed.

Giving money to your heirs while you are still alive (gifting) is one way to reduce the size of your estate. This was a hot topic when I first got into this business in 2001 because the exemption was only $675,000 and the tax rate on every dollar above that was 55%. Ouch! Thankfully, the exemption limit has been raised to $5.49 million per person (in 2017) and will be increased for inflation each subsequent year. The other piece of good news is the tax rate on every dollar above the limit has dropped to a super-reasonable 40%. 🙂

You can also transfer any unused portion of your exemption to your spouse. So married couples can transfer close to $11 million in 2017 without any estate tax. This means that only about 1 in 517 households who file an estate tax return in 2017 will owe any estate taxes. These thresholds apply whether or not you have a living trust or any estate planning documents in place.

Gifting has become unnecessary for most households:

The net effect of the higher estate exemption is gifting has become unnecessary for most households as a tax minimization strategy. However, it may still be attractive for the sake of seeing your heirs enjoy the money while you are still alive.

The .2% of households over the exemption limit tend to jump through a lot of hoops to minimize the value of their estates for estate tax purposes. This must be done in advance and may include various types of irrevocable trusts, family limited partnerships, foundations, and gifting.

Important considerations and exceptions when gifting:

Tax issues are always a bit more complicated than we want them to be. So here are a few other important considerations and exceptions:

  1. You can generally avoid paying gift tax even on gifts above the $14,000 annual exemption. All you have to do is file a gift tax return (IRS Form 709 to let the IRS know that you are using up part of your ($5.49 million) estate tax exemption while you are still alive.
  2. Some gifts are unlimited and will not trigger any estate tax, gift tax, or require a gift tax return. These include:
    • Gifts to approved charities.
    • Gifts to your spouse (assuming he or she is a US citizen).
    • Gifts to pay for another person’s medical expenses. Payments must be made directly to medical service providers.
    • Gifts to pay for another person’s tuition expenses. Payments must be made directly to the educational institution.
  3. In addition to the federal estate tax of 40 percent, some states impose their own estate or inheritance tax, which may have different exemption limits. Fourteen states have an estate tax while six have an inheritance tax. Maryland and New Jersey have both.

Have a great week and email me with questions.