understanding gift tax

How Much Do I Pay in Gift Tax

Most people will gift some money away during their lifetime, usually to a family member. Think of all the grandparents that gift college money or birthday money to a grandchild or great-grandchild. Some people come into money and want to help family members with their finances by gifting them a part of their newfound wealth.  Others are parents who want to help their children pay for their first house or wedding.

This is great news for everyone involved, the problem remains that gifts result in a lot of tax liability questions. Who is on the hook to pay the tax for the gift? How much of it will be taxed?  What could you do to lower the tax burden? These are all common questions associated with gifting money or assets. Gift tax is a very complex and misunderstood financial concept that we’d like to help clarify.

What is Considered a Gift

Most people immediately think of money as the gift that everyone is giving. However, the IRS defines a gift, “as any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.

Basically, any item you give to another, for which you do not receive money or some other consideration back, could be considered a gift. Next time you give that stick of gum to your buddy, you are giving a gift in the IRS’s view.

Clearly, the IRS doesn’t want to deal with the administrative burden of tracking all these small gifts, so they have established some exclusions. Nontaxable gifts are gifts under the annual gift tax exclusion, direct payments to a college or medical institution, gifts to your spouse, or gifts to a political organization.

If you give a house or other asset, you must think about the fair market value of the item you are gifting. Fair market value, “in the simplest sense, is the price that property would sell for on the open market. A term commonly used in tax and real estate, fair market value has come to represent the price of an asset under the following usual set of conditions: Prospective buyers and sellers are reasonably knowledgeable about the asset, behaving in their own best interests, free of undue pressure to trade and given a reasonable time period for completing the transaction. Given these conditions, an asset’s fair market value should represent an accurate valuation or assessment of its worth. You can’t gift a house to someone and say the fair market value is a lot less than what it really is to get around the gift tax liability.”

Unfortunately, you cannot gift your house away and argue that the house isn’t worth anything because you want to skirt the gift tax rules. You must gift the house and value it as if you were willingly selling it an individual that wants to buy it.

How the Annual Gift Tax Exclusion Works

The annual gift tax exclusion is per person, per recipient. If you are married and want to give money to your son and his wife, you could give $60,000 and remain within the gift tax exclusion. That is because you can give $15,000 to your son and $15,000 to his wife, and your wife can give $15,000 to her son and $15,000 his wife, for a total of $60,000.

You get this same exclusion every year no matter if you’ve used it in past years or not. If you and your wife give $60,000 to your son and his wife on December 25th, you and your wife can give another $60,000 to your son and his wife on January 1st and remain within the gift tax exclusion.

To give a gift under the annual gift exclusion is extremely easy. You simply give the gift! No additional steps are necessary until you go over the exclusion amount.

Direct Payments to a College or Medical Institution

The IRS also excludes direct payments to a college or medical institution. The key here is that the payments must be made directly to the institution. If you want to pay for your grandchild’s college tuition, which is currently $100,000, you don’t want to write your grandchild the check. If you make the check out to your grandchild, it will be considered a gift to them and it is above the annual exclusion amount. However, if you make the check directly out to the college, there would be no gift in that case. The same goes for paying someone’s medical bills. Making the check out to the person will count as a gift, whereas a check made out to the medical institution will not.

What Happens When You Go Over the Gift Tax Exclusion

Sometimes you are feeling extremely generous and you want to give a gift that does not fall into any exclusions. The burden of the gift is always on the donor, not the donee. The person that is giving the gift is the person responsible for filing the necessary documents and/or paying any tax liability, not the person receiving the gift.

The IRS has doubled down on their gift tax exclusions. On top of the annual gift tax exclusion listed above, the IRS also has the Estate and Gift Tax Exemption. This is not an annual amount, but a lifetime amount. In 2018, the exemption is $5.6 million per person or $11.2 million for a married couple. Note that this is per person, not per recipient. You cannot give $5.6 million to your son and $5.6 million to his wife tax-free. However, you could give $5.6 million to your son, and your wife could give $5.6 million to her son and be okay.

With all these exemptions and exclusions, you will have no tax liability until you give more than these thresholds. Even if you give $100,000 this year to one person, you will not have to pay tax on the $85,000 that is over the annual gift tax exclusion.

For once the IRS doesn’t seem to want your money when you are just giving it away. The truth is, you’ve probably already paid tax on this money at some point and they see no reason to make you pay tax on it again.

When you go over your annual gift tax exclusion, you do have to file a form letting the IRS know that you went over the exclusion amount. The form you have to file is Form 709 and it is relatively straightforward. The form will detail how much you gave, how much you gave over the exclusion, and they will make you sum up any amounts from all previous gifts in which you went over the limit.

Using the example above, you would have to let them know you were over the exclusion amount by $85,000. They would subtract that amount from your $5.6 million lifetime exemption, and you would be left with $5,515,000 in lifetime exemptions.

What Happens When the Estate and Gift Tax Exemption Run Out

The government made sure that only a small percentage of individuals will be affected by the Estate and Gift Tax Exemption. They typically quote that it will only affect the top 1% of people in the United States. The government will most likely keep raising the exemption or eventually just get rid of it all together. Again, this is a tax on money that has most likely already been taxed, and is not a big revenue driver.

Usually, you will not go over the exemption amount while you are alive. What happens is that you pass away and all the items in your estate can add up to over $5.6 million. This may be true if you own several homes, especially if they are in high-cost housing areas like California or New York.

If your estate is valued at more than your remaining lifetime exemption, your estate will be taxed at up to 40%. This rate is graduated, increasing from 18% for having a taxable estate of only $10,000 and increasing up to 40% for a taxable estate of over $1 million.

Conclusion

We could easily fall down the rabbit hole when considering the possibilities of estate and gift taxation. Estate taxation information can be intense, and once you reach that point, your situation can become extremely complicated. If you have a large estate and fear going over the lifetime exemption, you should consult an estate attorney.

If you are just worried about giving gifts, that is much more easily managed . You now know that there is an annual exclusion amount of $15,000 per person, per recipient. You don’t have to worry about gifting limits if you gift directly to a qualified college or medical institution on behalf of someone else. And, even if you do want to give more money away, all that you must do is file an IRS form to declare it. There won’t be any tax liability until you reach the lifetime exemption.

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