How Does the Gift Tax Work?
Gift givers — not gift recipients — have to pay gift tax, but you won't owe the gift tax until you've given away more than $5 million in cash or other assets during your lifetime. Simple enough. But you may still have to file gift tax returns even though you don't owe any tax.
The annual federal gift tax exclusion allows you to give away up to $14,000 in 2016 or 2017 to as many people as you wish without those gifts counting against your $5.45 million lifetime exemption, a figure that is going up to $5.49 million in 2017. (The tax reform bill passed at the end of 2017, and other adjustments, changed some of the limits, so be sure to check current rules.)
Gifts made during your lifetime will reduce your taxable estate. So make annual gifts up to the exclusion of $14,000 as a smart way to reduce your taxable estate without any negative side effects.
So far, so good. Here are types of gifts that are exempt from federal gift tax — you can make unlimited gifts in these categories without gift or estate tax consequences and without having to file gift tax returns:
- Gifts to IRS-approved charities.
- Gifts to your spouse if she or he is a U.S. citizen.
- Gifts covering another person's medical expenses as long as you make the payments directly to the medical service providers.
- Gifts covering another person's tuition expenses as long as you make the payments directly to the educational institution.
So, then, when do you need to file a gift tax return? If you make a taxable gift — in excess of that annual exclusion amount — you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return. The return is due by the following April 15 (postponed in years when April 15 falls on a weekend or legal holiday).
If you're married, you can't file a joint gift tax return. Each spouse who makes any taxable gifts must file a separate return. You can split gifts with your spouse; making a split gift allows you to take advantage of your annual gift tax exclusion plus your spouse's exclusion even for a gift that's made entirely by you.
Sounds a bit confusing: You don't owe tax, but you need to file a gift tax form anyway. What's up with this? The federal gift tax exists for one reason: to prevent citizens from avoiding the federal estate tax by giving away their money before they die. You have an annual gift exclusion, but if you go beyond that, you begin to eat into the exclusion that offsets the bill on the first $5.45 million ($5.49 million in 2017) of lifetime gifts and you'll have to pay the gift tax — at rates that mirror the individual income tax — up to 40 percent.
By considering the different rules that determine the tax basis of property that someone receives by gift versus inheritance, you'll be wise about transfer of property.
And what gifts are subject to the gift tax? Checks, adding a joint tenant to real estate, canceling indebtedness, making a payment owed by someone else, making a gift as an individual to a corporation, giving real or tangible property located in the U.S. or, if you are a U.S. citizen, making a gift of foreign real estate.
The benefit of making a gift, then, is that you reduce estate taxes; it amounts to shifting assets to family members in lower tax brackets. And — here's another really good advantage — you teach family members how to manage wealth.