How Much Do I Pay in Gift Tax
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
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
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
What Happens When You Go Over the Gift Tax Exclusion
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
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.
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.