The gift tax may be one of the least understood provisions of the tax code.
It can be hard to understand why you may owe taxes just by giving something away, and its annual and lifetime aspects make it confusing for people who don’t do taxes for a living.
Most people will never pay the gift tax, but it’s still wise to understand how it works and when you might be on the hook to pay it.
This is especially the case if you want to help your kids financially or decrease the value of your estate before you pass away.
Learn why the gift tax exists, what does and doesn’t count as a gift and other aspects of the gift tax that you’ll want to know if you ever owe it.
Why the Gift Tax Exists
It may sound ridiculous that you may be liable for taxes on gifts you make with your own money, but the gift tax has a purpose.
It exists to prevent taxpayers from giving away all their money before they die to avoid paying the federal estate tax.
What Constitutes a Gift?
“Per tax law, a gift is when you give property — including money — or the use of or income from property without expecting to receive something of at least equal value in return,” says Jeffrey Schneider, an enrolled agent and owner of SFS Tax and Accounting Services. “If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”
There are, however, a few situations in which a gift isn’t considered taxable, including:
- Gifts to a spouse
- Gifts to a political organization for its use
- Tuition or medical expenses paid on behalf of someone else
- Gifts with a value below the annual exclusion threshold per person ($15,000 in 2018)
Note that there are some caveats with some of these exceptions. For example, if your spouse is not a U.S. citizen, you can only gift up to $149,000 tax-free.
Also, to qualify for the educational and medical exclusions, your payments must be made directly to a qualified educational organization for tuition, or to the person or medical institution that provided medical care.
It also doesn’t apply to amounts reimbursed through the donee’s medical insurance plan, nor to books, supplies and other educational expenses.
If your educational or medical gift doesn’t follow these guidelines, it will be subject to the $15,000 annual exclusion amount.
If you contribute to a qualified tuition program, such as a 529 College Savings Plan, you’re allowed to contribute up to five years’ worth of your annual gift tax exclusion ($75,000 in 2018) without counting any of it as taxable.
That said, any other gifts you make to that person in the following five years would be considered taxable and will reduce your lifetime gift tax exemption amount.
How to Calculate the Value of a Gift
If you’re gifting someone cash, it’s easy to calculate the value of that gift.
But if you’re gifting a family home, car, or another asset, it can get a little more complicated.
The IRS determines the value of your gift by its fair market value.
The fair market value of an asset is its price in a sale between a willing buyer and seller where both know all of the relevant facts, and neither is under compulsion to buy or sell.
In other words, the figure is essentially how much you would sell the asset under normal circumstances if you weren’t gifting it.
So, you may need to get the asset appraised to determine its fair market value.
Who Pays the Gift Tax?
In most situations, the donor or the donor’s estate is responsible for paying taxes on taxable gifts that exceed the lifetime exclusion threshold.
In some cases, however, the person who received the gift may agree to pay taxes.
Consult with a tax professional to understand when this is a good option to consider.
How the Gift Tax is Calculated
The amount you’ll pay in gift taxes depends on how far you go over the lifetime exclusion threshold. The rate can range from 18% to 40%.
Gift Tax Rate
|Taxable Amount (In Excess of $10 Million)||Gift Tax Rate|
|$1 to $9,999.99||18%|
|$10,000 to $19,999.99||20%|
|$20,000 to $39,999.99||22%|
|$40,000 to $59,999.99||24%|
|$60,000 to $79,999.99||26%|
|$80,000 to $99,999.99||28%|
|$100,000 to $149,999.99||30%|
|$150,000 to $249,999.99||32%|
|$250,000 to $499,999.99||34%|
|$500,000 to $749,999.99||37%|
|$750,000 to $999,999.99||39%|
|$1,000,000 or more||40%|
This means that you don’t necessarily owe taxes on gifts of more than $15,000 per person. Rather, the amount you gift above that threshold gets deducted from your lifetime exclusion amount, which is currently $10 million.
For example, if you gift your house worth $250,000 to your daughter and her husband, you’ll report the full amount as a taxable gift, but only $235,000 of it reduces your lifetime exclusion amount.
You won’t owe taxes on the $235,000, but you can only give $9,765,000 more in taxable gifts in your lifetime before you have to pay the gift tax.
This may not be a big deal if you don’t have a lot of assets.
But, if you have a big estate that you want to gift to your loved ones when you die, it could cause some problems down the road because of a lower lifetime exemption amount.
How to Report Your Gifts
“If you give more than the annual gift tax exclusion, you would have to file a gift tax return,” says Schneider.
But you don’t report gifts on your normal tax return like you do most other expenses. Instead, you’ll fill out Form 709 and file it by April 15 of the year after which you made the gifts.
Using this form, you’ll share information about each gift you’ve made throughout the year, including:
- The donee’s name and address
- Your relationship with the donee
- A description of the gift
- The date and value of the gift, including your adjusted basis
If you split a gift with your spouse, he or she will need to sign and date the form proving that consent.
Also, be sure to include the following when you file the form:
- Copies of appraisals, if applicable
- Copies of relevant documents involved in the transfer
- Documentation of any unusual items included in the return, such as partially-gifted assets and other relevant items
“Depending on previously reportable gifts,” says Schneider, “you may have to pay a gift tax if you are over the lifetime exclusion.” If you do owe, you can include payment when you file.
How to Avoid the Gift Tax
For most people, the gift tax will never come into play, but it’s still wise to plan as if it may in the future.
Let’s say you want to write a check to your child for $20,000 to help with a home down payment or transfer the title of your car, which has a fair market value of $40,000, into your child’s name.
In either case, you may or may not have to report a portion of your gift as taxable, depending on your tax filing status and how you structure the gift.
For example, if both you and the donee are single, you’re limited to the $15,000 annual exclusion threshold, and the amounts above that annual threshold would be considered taxable. That would be $5,000 for the check and $25,000 for the car.
But if you and the donee are both married, you could make either gift without any tax consequences.
That’s because a gift of joint property made by a couple effectively doubles the threshold amount — $15,000 from mom and $15,000 from dad, for example.
You and your spouse can also make an additional $15,000 gift each to a son- or daughter-in-law.
So, a gift from one couple to another couple could be worth as much as $60,000 without triggering the gift tax if you split them up correctly.
The gift tax can be tricky if you don’t understand its nuances. What’s most important is that your gifts that exceed the annual exclusion threshold aren’t necessarily taxable for that given year.
Instead, they’ll reduce the lifetime exclusion amount. Once that’s gone, you or your estate will owe the gift tax.
Again, most people won’t ever have to deal with gift taxes.
But if your financial goals include having a large estate to pass on to your loved ones, it makes sense to avoid making taxable gifts even now.
By planning to avoid gift taxes early on, it will be a lot easier later in life to do your estate planning and could potentially save your loved ones a lot of money.