A question that comes up every year from friends or clients is, “How much can I give my child, grandchild, or friend so we don’t have to pay tax on it?” The money you give to other individuals, whether or not they’re related to you, may not be taxable to them or you, within certain limits, but may have tax ramifications for them, depending on the nature of the gift.
If you’re in a position to help out family members or friends, or if you’re wondering how best to transfer your estate after you pass on, it’s important to be aware that it isn’t always free.
Some gifts are not subject to tax, but others are. A quick study of the IRS gift tax regulations can prevent you from taking an unnecessarily large tax hit and help you plan how to best transfer your wealth. In addition to familiarizing yourself with IRS gifting rules, it’s also advisable to contact an estate planner or attorney to make sure your heirs receive the gifts or bequests you intend for them.
What Is a Gift?
Leave it to the IRS to take a word that sounds perfectly simple and pleasant and give it a complicated definition. IRS Publication 559, “Survivors, Executors, and Administrators,” says, “A gift is made if tangible or intangible property (including money), the use of property, or the right to receive income from property is given without expecting to receive something of at least equal value in return.” Basically, gifts are money or things you give to someone for which you do not receive something of equal value in return.
By that definition, gifts come into play in many situations, such as giving money to a friend or family member just to help them out. You could give someone a car or furniture or the use of your vacation home as a gift, and it might not be taxable. Or, you could forgive a debt someone owes you, and that could be considered a gift.
Gift taxes, in all but the rarest of circumstances, are paid by the person who gives the gift. However, don’t confuse generosity with charity. Gifts to charities can be deducted if you itemize your deductions. Gifts to individuals, however, are not deductible. The recipient does not have to declare the gift as income, and you do not get a deduction for making the gift.
Understanding the Gift Tax
Any individual can receive a gift up to the federal gift-tax exclusion amount, which is $14,000 per year for tax years 2015-2017, without having to report the gift or the donor having to pay tax on it. The gift-tax exclusion goes to $15,000 for 2018. The exclusion applies per gift, not to the total of gifts given.
Further, gift givers can subtract amounts greater than $14,000 from a lifetime exemption amount (without having to pay taxes on it). The lifetime exemption is known as the unified credit, which is $5.49 million for 2017. However, givers must report these gifts to the IRS by filing a gift tax return, or Form 709.
Keep in mind that tapping your unified credit reduces the amount that can be excluded from your federal estate tax when you die. For example, if you use $2 million of your unified credit in 2017, your estate tax exclusion would be $3.49 million instead of $5.49 million.
As long as your individual gifts are less than the annual gift-tax exclusion amount, you may give to as many individuals as you’d like – you won’t reduce your unified credit or, in turn, your estate tax exemption.
For a taxpayer and spouse, the gift-tax exclusion applies to each person. So, you could give a person up to $28,000 in 2017 ($30,000 in 2018), if the gift is deemed to be split between them – half given by the taxpayer and half by the spouse.
For example, suppose that George gave a gift to Byron of $21,000, and his wife Wilma gave a gift to Francine of $18,000. Both gifts are greater than the gift exclusion of $14,000. However, if they are split, Byron’s gift would be attributed half ($10,500) to George and half ($10,500) to Wilma. Similarly, Francine’s gift would be attributed half ($9,000) to George and half to Wilma ($9,000).
So, by splitting, neither George nor Wilma has exceeded the gift-tax exclusion with either Byron or Francine. However, George and Wilma each need to file a gift tax return, Form 709, because they are splitting the gifts. If you live in a community property state, gifts of community property are deemed to be given half by each spouse, and a gift tax return must be filed.
Keep in mind also that the unified credit of $5.49 million applies to each the taxpayer and spouse. So, the combined unified credit for a couple is $10.98 million in 2017.
Tax Exemptions for Gifts
Fortunately, there are plenty of circumstances in which you can provide assistance but needn’t declare that assistance as a gift. The Instructions for Form 709 detail these exceptions:
- Education: If you pay your niece’s college tuition, even if it costs more than $14,000 per year, it isn’t considered a gift, as long as it is paid directly to the institution. In fact, educational expenses paid directly to the institution aren’t considered gifts at any educational level, not just college.
- Health: If your brother has heart surgery and you pay the bills directly to the hospital because he doesn’t have health insurance, or if your grandmother needs assistance and you pay for a home health aide, the cost would not be considered a gift, if paid directly to the medical care provider.
- Spouse: If you and your spouse maintain separate bank accounts or investment accounts, you may give each other as much money as you’d like without considering it a taxable gift. There is one catch: You must both be American citizens. The yearly limit for gifts to a spouse who is not a U.S. citizen is $149,000 in 2017.
- Politics: You may donate to political organizations without paying any taxes. These are not charitable donations, however, so you can’t deduct them on your return.
Different Forms of Gifts
When gifts take the form of stocks or real estate, the $14,000 per person limit still applies. Gift givers must base their numbers on fair market value. For example, if you give a gift of stock shares, you’d calculate the market value of your stock on the day it’s transferred. If you are gifting property, you must get an appraisal to determine the current value.
You should also provide the recipient with your cost basis – how much the stock (less brokerage fees) or property cost you when you bought it (plus improvements, minus depreciation, if any) – so the recipient can calculate the gain, should they sell it. For a gift given during the donor’s lifetime, the donor’s basis is the basis for the recipient. Gifts of property received on the death of the donor get a stepped-up basis to fair market value on the date of death.
An example may help. Suppose you bought 100 shares of stock at $10 each. Your basis is $1,000. Let’s assume you transfer them to your son when the shares are worth $100 each. If your son holds them for several years, then sells them at $120 each, he will have a capital gain. Disregarding brokerage commission, his proceeds would be $120 x 100 = $12,000. So, his capital gain is proceeds – basis, or $12,000 – $1,000 = $11,000.
Similarly, if you gift your daughter a house that was worth $100,000, but you purchased it for $60,000, even if she sells it for $100,000, she still must pay capital gains taxes on a $40,000 gain. Regardless of your particular situation, it pays to speak with a qualified estate planner and tax professional to best determine how to transfer your wealth and maximize your tax strategy.
Most people enjoy giving to their family and friends, and with the rising limits on the gift-tax exclusion, it’s becoming easier for everyone. The rules are complicated, though, so it’s best to consult with a tax professional when considering this financial move. Keep in mind that if you are married, even if you file taxes jointly, you and your spouse need to fill out separate gift tax forms – Form 709 – since you each have your own unified credit “bank” to use up during your lifetime.
Are you planning on using gifts to reduce your estate or help your family?