What Is the Gift Tax, and How Does It Work?
The gift tax is something a lot of people have heard of, but not many people understand. Some people think that if they receive a gift above a certain amount, they have to pay taxes.
Thankfully, that’s not how the gift tax works in most cases. In reality, very few people ever pay it. However, it’s important to understand how it works. This way, you’ll feel comfortable with both giving and receiving gifts in the future.
What Is the Gift Tax, Exactly?
You’ll have to pay gift tax only in rare circumstances, and it’s usually focused on specific transactions. In particular, it comes into play in situations when a donor transfers money or an item of value to the donee (person receiving the gift) and the donor does not receive the full value of the gift in return.
For example, let’s say your grandparents wanted to give you a used car worth $10,000 without receiving anything in return. This would qualify as a gift for gift tax purposes.
Most gifts qualify as taxable gifts, but as with anything else tax-related, there are exceptions.
The following are generally excluded from the definition of gifts:
- Gifts to your spouse
- Tuition and medical expenses
- Gifts to a political organization for its use
- Gifts less than the annual exclusion for the calendar year
What confuses most people is who’s responsible for reporting and paying any applicable gift tax. Except under rare circumstances, the donor is the one who must fill out a gift tax return and pay any gift tax due.
How Does the Gift Tax Work?
“Each person can give away $15,000 per person without having it count toward their lifetime credit,” says Michael Dinich, a financial adviser at Your Money Matters and the founder of personal finance blog Your Money Geek. More on the lifetime credit in a minute.
The Minimum Gift Amount
In 2019, you, as an individual, must give over $15,000 to a single person before you even have to contemplate paying gift tax or filing a gift tax return in most cases. This $15,000 minimum is known as the annual exclusion amount. If you give less than that to each individual you give a gift to in a tax year, you don’t have to worry about filing a gift tax return or paying gift tax.
If you exceed the $15,000 per person gift limit, you’ll move on to the next step. In 2019, you have a lifetime estate and gift tax exemption of $11.4 million dollars. Each gift you give above the annual exclusion limit comes out of your lifetime estate and gift tax exemption, except for the excluded gifts discussed earlier.
Marriage and the Gift Tax
If you’re married, it’s even easier to avoid paying gift tax or filing a gift tax return. You and your spouse each get a $15,000 annual exclusion amount for a total of $30,000 per year for each individual you give gifts to. Plus, each spouse gets an $11.4 million dollar lifetime estate and gift tax exemption for a total of $22.8 million.
Essentially, only the super-rich will end up being subject to the gift tax.
That said, regular people may have to file gift tax returns. If you exceed the $15,000 annual exclusion amount ($30,000 for married couples), then you may have to file a gift tax return to report the gift and use part of your lifetime estate and gift tax exemption. The gift tax return is Form 709. You can learn more about it on the IRS website.
Ways to Give Money Without Losing Your Lifetime Estate and Gift Tax Exemption
Let’s say you’re hoping you’re going to be filthy rich when you eventually die. You don’t want to pay estate taxes, so you want to keep your lifetime estate and gift tax exemption to pass on your wealth. What can you do to preserve as much of the $11.4 million exemption?
If you’re married, you can be creative with who gives your gifts to maximize the $15,000 annual exclusion.
First, you can give an individual $15,000. Then, your spouse can give that same person another $15,000 for a total of $30,000 in gifts without touching your lifetime estate and gift tax exemption.
But what if you want to give more than $30,000? If you’re near the end of a year, a bit of planning can make things work. Have both you and your spouse give $15,000 each before the end of the year.
Then when the calendar rolls over to January 1, you can give up to the annual exclusion in the next year, as well. Sometimes, the annual exclusion increases due to inflation, so it’s possible that the 2020 annual exclusion could be larger than $15,000 per individual.
If you’re feeling super generous, you may be able to give even more money, depending on who you’re giving it to. Let’s say you want to give money to your son’s family. If your son is married, you and your spouse can individually give $15,000 each to both your son and your daughter-in-law. If you do this at the end of one year and the beginning of the next year, that’s $120,000 in gifts without touching the lifetime estate and gift tax exemption.
Consult a Professional
If you or you and your spouse have an estate worth anywhere near the lifetime estate and gift tax exemption, you should consult a tax professional to see how to properly structure your estate to minimize any gift and estate taxes you may end up owing. You might also want to enlist the help of tax programs like H&R Block and TaxAct.
If you don’t have $11.4 million laying around — and I certainly don’t — at least you don’t have to worry about paying gift and estate taxes. However, you don’t have to be rich to have a need to consult a professional. People often confuse the gift tax with other financial planning topics. Professionals can make sure everything is done correctly.
“The biggest confusion is people think the annual exclusion applies to Medicaid. However, making gifts can impact your eligibility for Medicaid should you need to go to a nursing home,” Dinich says.
“Before signing property over to loved ones, check with a competent estate planning attorney. DIY estate planning could make you ineligible for Medicaid, subject the property to gift taxes, cause your family to lose the favorable step-up in basis on death, and expose the home to creditors of the new owners.”