Giving Monetary Gifts

A gift is any transfer of property from one person to another. The Internal Revenue Service (IRS) does not distinguish between gifts of money and gifts of other types of property. Gifts given during a donor’s life are either tax exempt or subject to a gift tax. Gifts that transfer at death are subject to an estate tax. In 2011, the gift tax limit and estate tax limit were combined to create a lifetime gift tax exemption. This exemption allows a certain value of transferred property to be exempt from federal taxes, whether it is transferred during a donor’s lifetime or at death. At death, the value of all transfers of property—including those made as gifts during the donor’s lifetime and those that transfer from an estate via a will or as intestate property—are calculated. Any property transfers that exceed the current lifetime gift tax exemption are taxed. In 2015, the IRS set the lifetime gift tax exemption at $5.43 million. This limit is subject to change and may be increased or decreased in the future.

Background

The IRS defines a gift as the transfer of property when there is no exchange of anything of value in return, or when something less than the full value of the property is exchanged in return. A gift may be either taxable or tax exempt. Tax-exempt gifts includes gifts to qualified spouses, political organizations, and charities; gifts that fall below the annual gift tax exclusion; and gifts paid directly to medical providers, health insurers, and educational institutions.

Gifts to spouses fall under the IRS’s marital gift deduction. This deduction allows an individual to give unlimited gifts to a spouse tax-free as long as the spouse is a US citizen. If the spouse is not a US citizen, the IRS allows only a specific value of property to be given tax-free every year. In 2015, that amount was $145,000. Gifts to noncitizen spouses in excess of $145,000 a year apply against the lifetime gift tax exemption.

Gifts to qualified charities are also exempt from taxes. In addition to being tax-free, they may be deducted from the amount of estate taxes. Gifts to political organizations that are classified as 501(c)(4) groups are also tax-free. These groups may include some political lobbying groups as well as nonprofit social welfare organizations, such as civic leagues, volunteer fire organizations, and homeowners associations.

The IRS allows individuals to gift others a certain value of property each year that is exempt from taxes. In 2015, the annual gift tax exclusion was $14,000 per gift recipient. This exclusion applies to the total value of property a donor transfers to another person in a year, not the total value of gifts to all persons within a year or each separate gift. For example, a parent could give annual gifts of $14,000 to each of his eight children tax-free. If, however, the parent gave annual gifts of $15,000 to each child, $1,000 of each gift would be taxable. Similarly, if a parent gave a child two gifts of $14,000 within one year, $14,000 would be taxable.

Spouses can split gifts. The split gift exemption allows one spouse to give a gift up to twice the annual exclusion amount and split the gift with the other spouse. For example, a father could give his son $28,000 and then split the gift with his wife, so each spouse gave a gift of $14,000. In this case, neither spouse could give another gift to the son without exceeding the annual gift tax exclusion limit.

Overview

The federal government taxes most gifts. A very small number of states also tax gifts. The donor of a gift is responsible for paying any taxes due. In most cases, the recipient of the gift does not have to pay taxes on the gift. The exception is gifts of future interest, such as stocks that change their value from the time they were received to the time they were sold. The recipient would be responsible for any taxes that result from the appreciation of the stock from its value at the time it was gifted.

The majority of people will not owe federal taxes on gifts they give to others. The lifetime gift tax exemption allows people to transfer property up to a certain limit without it being taxed. Any property transferred in excess of that limit is taxed. As the lifetime gift tax exemption was $5.43 million for 2015, only people with assets greater than that amount are likely to owe federal taxes on gifts made during their lifetime or as property transfers at death for that year.

Taxpayers are required to file the IRS Form 709 to report any gifts in excess of the annual gift exclusion for every year in which this occurred. For example, if an individual gave a family member $20,000, the individual would need to report a gift of $6,000 in excess of the annual exclusion limit. Each gift beyond the annual exclusion accumulates and is deducted from the lifetime gift tax exemption. For example, if an individual gave gifts in excess of the annual exclusion of $100,000 every year for twenty years, at death the total value of gifts during that person’s lifetime would equal $2 million. This amount would be deducted from the lifetime gift tax exemption and the remainder would show how much of the estate was tax-exempt. If the donor in this example died in 2015, the amount of the estate that could transfer to others tax-free would be $3.43 million. If the estate had a value of $4 million, the taxable amount would be $0.57 million.

Spouses who split gifts also need to file the IRS Form 709 to show the gift was split and was not an individual gift that exceeded the annual gift exclusion. IRS Form 709 also must be filed when individuals give a gift of a future interest to someone other than their spouses or give a spouse an interest in property that terminates in the future.

Taxpayers do not need to report gifts to political groups or those made as payments directly to an organization for health insurance, medical expenses, or tuition.

For people with property in excess of $5.43 million, transferring property to avoid high estate taxes is an important part of their estate planning. Transferring property by making tax-free gifts during the donor’s lifetime can reduce the amount of property in an estate at death, and thus reduce or eliminate the federal and state estate taxes owed.

A typical strategy to limit estate taxes is to make annual tax-free gifts to one’s spouse, children, grandchildren, and other relatives or friends. In this way, a percentage of one’s estate can be transferred without being subject to the estate taxes or applied to the lifetime gift tax exemption. An alternative is to give gifts up to the lifetime gift tax exemption to children, grandchildren, and others and then to bequeath any property in excess of that exemption to one’s spouse (for whom there is no gift limit). Tax-free gifts to qualified charities and political organizations also reduce the size of an estate and its taxable assets.

Other strategies involve giving gifts during one’s lifetime so they meet the annual exclusion limit. For example, a parent may want to give an interest-free loan to a child. Any amount of this loan over the annual exclusion would be taxable. An alternative would be to give the loan and then forgive an amount equal to the annual exclusion each year until the loan is paid off. No taxes would then be due nor would the loan amount apply against the lifetime gift tax exemption.

Individuals can avoid having money spent on the health insurance or medical expenses of adult children or elderly parents being taxed as a gift if the donor makes payments directly to the insurance company or service provider. The same applies to educational expenses for tuition. Payments made directly to a medical provider or educational institution are not considered gifts and are exempt from federal taxes.

Another strategy to pay for educational expenses is to fund a Section 529 college savings plan for a family member. Any amount up to the annual exclusion can be donated to the fund tax-free. A larger amount can be given as a lump sum and then distributed over a five-year period to apply against the annual exclusion limit.

Bibliography

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