What is the gift tax and how does the gift tax work?
In the course of financial planning for clients we often get asked about the gift tax. Most commonly we’re asked “what is the gift tax?” and “how does the gift tax work?” It’s important to start with the basics and understand how the gift tax will affect you before making any gifts to friends or family.
What is a gift for “gift tax” purposes?
First of all, a gift is any transfer to another person directly or indirectly which will not be repaid. So for example, if you want to gift $10,000 to a grandchild to purchase a car or buy a new home and there’s no expectation of any repayment, that qualifies as a gift for gift tax purposes.
Generally any gift is a taxable gift for IRS purposes. That being said there are several exceptions to the tax consequences for gifts:
- Gifts under the annual exclusion each year are not taxable. The annual gift tax exclusion for 2016 is $14,000 per donee (meaning a husband and wife could each gift $14,000 to someone for a total of $28,000)
- Tuition
- Medical expenses
- Gifts between spouses
- Gifts to political organizations
- Gifts to qualifying charitable organizations
Who pays the gift tax and how?
Generally the person making the gift pays the gift tax, although sometimes the recipient may agree to pay the tax instead. These gifts are not deductible on your income tax return (unless made to charitable organizations).
If you make a gift that doesn’t qualify for the exceptions noted above, you’ll need to file IRS form 709.
Can I gift property?
You can gift property whether you own it individually or separately. You’re still bound by the annual gift tax exclusion regardless.
Does any of this really matter?
Taxable gifts which you file form 709 to report aren’t so bad. Under current law, you’re allowed to gift $5.43 million dollars during your lifetime before you must pay the gift tax. To put this another way, all gifting does is reduce dollar for dollar your $5.43 million exemption per individual when you die. So for example if you die with $4 million in assets and you’ve already given away $2 million dollars, your estate would pay taxes on $557,000 ($6 million in total beneficiary benefit minus the $5.43 million exemption).