Navigating the Art of Gifting: Understanding Tax Implications and Smart Strategies

Navigating the Art of Gifting: Understanding Tax Implications and Smart Strategies

Picture this: It’s a warm Sunday afternoon, and you’re surrounded by the familiar buzz of a family gathering. As the sun streams through the window, Grandma pulls you aside and, with a twinkle in her eye, slips an envelope into your hand, whispering, ‘For college, my dear.’ Fast forward a few years, and maybe you’ve landed a jackpot or received an unexpected inheritance. The first thought? Sharing the joy by helping out your younger brother with his student loans or supporting your cousin’s startup dream.

These acts of giving, whether big or small, aren’t just transactions. They’re heartwarming moments that strengthen bonds and build memories. But, there’s often a shadow lurking in the background of these generous gestures: the dreaded tax implications. The term ‘gift tax’ can sound intimidating, conjuring images of complex paperwork and potential financial pitfalls. But here’s the good news: with the right information, navigating this maze can be simpler than you think.

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’ 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. A fair market value “is the price that a 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.”

Breaking Down the Yearly Gift Tax-Free Limit

The government understands that people will usually gift money or assets away at some point in their lives, so they give you an annual gift tax exclusion. The current gift tax exclusion is set at $17,000 (in 2023), and this exclusion is reevaluated by the IRS each year.

How does the gift tax exclusion work?

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 $68,000 and remain within the gift tax exclusion. That is because you can give $17,000 to your son and $17,000 to his wife, and your wife can give $17,000 to her son and $17,000 to his wife, for a total of $68,000.

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 $68,000 to your son and his wife on December 25th, you and your wife can give another $68,000 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.

How to Gift Tuition or Medical Bills the Right Way

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.

Going Above and Beyond: Navigating Larger Gifts

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 2023, the exemption is $12.92 million per person or $25.84 million for a married couple. Note that this is per person, not per recipient. You cannot give $12.92 million to your son and $12.92 million to his wife tax-free. However, you could give $12.92 million to your son, and your wife could give $12.92 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 that you were over the exclusion amount by $85,000. They would subtract that amount from your $12.92 million lifetime exemption, and you would be left with $12,835,000 in lifetime exemptions.

When Generosity Hits the Ceiling: The Estate and Gift Tax Exemption

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 altogether. 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.

How to Navigate the Gift Tax

Document Everything
Whenever you give or receive a gift that has potential tax implications, document the details. Include the date, amount or value, recipient, and any other pertinent details. This can be immensely helpful come tax time.

Stay Updated on Limits
Every year, check the IRS website or speak with a financial advisor to get the latest gift tax exclusion limits. They can change, and staying informed is crucial.

Consider Spreading Out Large Gifts
If you’re thinking of gifting a substantial amount, consider spreading it across multiple years to make the most of the annual exclusion.

Set Calendar Reminders
If you’re making recurring gifts, set reminders on your calendar to ensure you don’t exceed annual limits inadvertently.

Consult Before Big Moves
Before gifting assets like properties or stocks, consult with a tax professional to understand the implications fully.

Review Form 709
If you believe you’ve exceeded the gift tax exclusion, familiarize yourself with Form 709. Even if you don’t fill it out yourself, knowing what’s on it can be beneficial.

Direct Payments for Education & Medical
If you’re considering helping someone with their education or medical bills, always pay the institution directly. This way, you can avoid the gift being counted towards the annual exclusion.

Plan for Future Gifting
If you know you’ll want to gift significant amounts in the future, start planning now. Discuss with family members, set up trusts, or explore other financial vehicles that might help manage gift and estate taxes.

Keep An Eye on Estate Valuation
Regularly assess the value of your estate, especially if you own assets like properties. This way, you can plan better for future gifting and avoid unexpected tax implications.

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 with 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 $17,000 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.

Glossary

Gift: A transfer of money, property, or other assets to an individual without receiving full consideration (usually monetary) in return.
IRS (Internal Revenue Service): The federal agency responsible for administering and enforcing the internal revenue laws in the U.S.
Annual Gift Tax Exclusion: A set amount that an individual can gift to another person each year without having to pay a gift tax or even report the gift.
Fair Market Value: The price an asset would sell for on the open market under normal conditions, where both buyer and seller have reasonable knowledge of the asset.
Nontaxable Gifts: Gifts that don’t incur gift tax or need to be reported. Examples include gifts under the annual gift tax exclusion, direct payments to educational or medical institutions, gifts to spouses, and gifts to political organizations.
Estate and Gift Tax Exemption: A lifetime exemption amount that each person has before they owe any gift or estate tax.
Donor: The person giving the gift.
Donee: The person receiving the gift.
Form 709: A U.S. federal tax form that individuals must file if they gift amounts greater than the annual exclusion limit in a year.
Taxable Estate: The total value of a deceased person’s money and property for which estate tax is due before any allowable deductions.
Estate Attorney: A legal professional who provides advice on estate planning and can help draft and implement documents like wills and trusts.