Gift Tax Basics
Sharing your wealth with family, friends, and loved ones may be easier said than done.
The IRS prevents the tax-free transfer of wealth both before and after death. The estate tax applies when you transfer wealth after death, and the gift tax applies when you transfer wealth during your lifetime. Although their rules are a bit different, the two taxes go hand in hand, which is something to be discussed later. But first, let’s go over the basics of gift taxes and discuss how the gift tax laws will impact you now and into the future.
Gift Tax Basics
The gift tax rules apply when you transfer anything of wealth – money, property, business interests, etc. – to somebody other than your spouse. However, this doesn’t mean that all gifts are taxable. Transfers that are always exempt from gift tax include:
• Charitable contributions;
• Certain political contributions;
• Direct payment of another person’s tuition or medical bills; and
• Annual gifts to individuals valued at $15,000 or less.
The last bullet point is critical. Each year, the IRS allows you to transfer up to $15,000 to any individual without using any of your lifetime exemption, as discussed below, before incurring a tax liability. This annual exclusion applies to each donee. That means that you can gift $15,000 to each of your five grandchildren every single year. This annual exclusion is regularly updated for inflation, but for tax years 2018 and 2019, it remains at $15,000.
When your annual gifts exceed $15,000, you must begin filing gift tax returns. Fortunately, your gifts will continue to be tax-free for some time. In addition to the annual exclusion of $15,000 per recipient, the IRS provides each taxpayer with a lifetime exemption. For 2019, the lifetime exemption is $11.4 million. Gifts above the $15,000 yearly exemption will eat into your lifetime exemption, and you will only be subject to tax when that exemption is depleted. Very few taxpayers will use the full exemption in their lifetime. Most only deplete the lifetime exemption after death, which is when the estate tax rules come into play.
The gift tax shares the same tax table as the estate tax. The maximum marginal tax rate for gift and estate taxes is 40%.
Frequently Asked Questions
There are a few more details that would be helpful to understand about gift tax law.
- Should my recipient report their gift as income?
No. As the giver, you will report the gift.
- Are gifts deductible? No. Making gifts will not affect your or your recipient’s income tax return.
- What is “gift splitting” and when should I use it? Gift splitting is when married couples split the value of a gift so that they can give more than $15,000 to an individual in a single year. Their annual exclusions can be combined. In other words, a spousal unit can gift up to $30,000 to a single recipient without incurring a tax liability. If you choose to split gifts with your spouse, you will be required to file a gift tax return so that you can make the gift splitting election.
- If I donate to a charity, does that donation count toward my lifetime exemption? No. Charitable contributions, certain political contributions, and paying educational and medical bills will not reduce your lifetime exemption.
- How do I know the value of a non-cash gift? If you donate something other than cash – such as artwork, business interests, or property – you will record your gift at “fair market value.” Fair market value is the value at which the property would change hands between a willing buyer and seller. To determine the fair market value of your gift, you may need to get it appraised.
- If I keep my gifts under the $15,000 annual exclusion, do I need to file a gift tax return?
Certain circumstances would require you to file a return even if your gifts do not exceed $15,000. If you split gifts with your spouse or if you gift future interests, you will need to file. Make sure that you keep any filed gift tax returns with your important papers as you will need them to keep track of your remaining lifetime exemption.
- My spouse is not a U.S. citizen. Can I gift them money? Yes, you can, but there is a separate annual exclusion for nonresident spouses. For 2019, this exclusion is $152,000.
James Emma is a Supervisor at Klatzkin and a member of the Estate Administration team.