A gift tax is imposed by the IRS if you transfer money or property to another person without receiving at least equal value in return. This could apply to parents giving money to their children, the gifting of property such as a house or a car, or any other transfer.
Whether or not the tax applies is dependent on a few factors, primarily the value of the gift. If the amount stays below the gift tax exclusion, you won’t have to worry about any tax. There are both annual and lifetime exemption amounts. The annual gift tax exclusion for 2019 is $15,000, and the lifetime exclusion is $11.4 million.
What Is the Gift Tax?
The IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration is not received in return.” In other words, if you write a big check, gift some investments or give a car to someone other than your spouse or dependent, you have made a gift. The IRS has a gift tax limit, both for the amount you can give each year and for what you can give over the course of your life. If you go over those limits, you will have to pay a tax on the amount of gifts that are over the limit. This tax is the gift tax.
In almost every case, the donor is responsible for paying gift tax, not the recipient. A recipient will only pay gift tax in special circumstances where he or she has elected to pay it through an agreement with the donor. Even though recipients don’t face any immediate tax consequences, they can face capital gains tax if they sell gifted property down the line.
There are two numbers to keep in mind as you think about gift tax: the annual gift tax exclusion and the lifetime gift tax exemption.
The Annual Gift Tax Exclusion
The annual gift tax exclusion is $15,000 for the 2019 tax year. (It was the same for the 2018 tax year.) This is the amount of money that you can give as a gift to one person, in any given year, without having to pay any gift tax. You never have to pay taxes on gifts that are equal to or less than the annual exclusion limit. So you don’t need to worry about paying the gift tax on, say, a sweater you bought your nephew for Christmas.
The annual gift exclusion limit applies on a per-recipient basis. This gift tax limit isn’t a cap on the total sum of all your gifts for the year. You can make individual $15,000 gifts to as many people as you want. You just cannot gift any one recipient more than $15,000 within one year. If you’re married, you and your spouse can each gift up to $15,000 to any one recipient.
If you gift more than the exclusion to a recipient, you will need to file tax forms to disclose those gifts to the IRS. You may also have to pay taxes on it. If that’s the case, the tax rates range from 18% up to 40%. However, you won’t have to pay any taxes as long as you haven’t hit the lifetime gift tax exemption.
The Lifetime Gift Tax Exemption
Most taxpayers won’t ever pay gift tax because the IRS allows you to gift up to $11.4 million over your lifetime without having to pay gift tax. This is the lifetime gift tax exemption, and it’s $200,000 higher than it was in 2018.
So let’s say that in 2019 you gift $215,000 to your friend. This gift is $200,000 over the annual gift exclusion. That means you will need to report it to the IRS. However, you won’t immediately have to pay tax on that gift. Instead, the IRS deducts that $200,000 from your lifetime gift tax exemption. Assuming you have never made any other gifts over the annual exemption, your remaining lifetime exemption is now $11.2 million ($11.4 million minus $200,000).
Most taxpayers will not reach the gift tax limit of $11.4 million over their lifetimes. However, the lifetime gift tax exemption becomes important again when you die and pass on an estate.
The Gift Tax & The Estate Tax
The federal government will collect estate tax if your estate has a value of more than the federal estate tax exemption. The exemption for 2019 is $11.4 million. At the same time, the exemption for your estate may not be the full $11.4 million. You can only exempt your estate up to the amount of your remaining lifetime gift tax exemption. So let’s say that you have lowered your lifetime exemption down to $10 million by making $1.4 million in taxable gifts. The federal government would then tax any estate that you pass on to someone for all value over $10 million. In other words, the gift tax and estate tax have a single combined exclusion. Regardless of whether the gift passed to the recipient before or after your death, it applies toward that same $11.4 million limit.
Tax rates on the estate tax go up to 40% just as with the gift tax.
All of this means that one way to prevent taxation of any assets you pass on is to gift those assets in increments of $15,000 or less. This could take some planning on your part but it is completely legal. There are also some gifts that you never have to pay tax on.
What Gifts Are Safe From Tax?
Taxable gifts can include cash, checks, property and even interest-free loans. It also applies to anything you sell below fair market value. For instance, if you sell your home to your non-dependent child for $175,000 when it’s worth $250,000, the $75,000 difference could be considered a gift. That surpasses the annual gift tax limit and thus is deducted from your lifetime gift tax limit.
What constitutes a gift that counts toward your gift tax limit is generally easy to understand. There are several things that the IRS doesn’t consider a gift, however. You can give unlimited gifts in these categories without facing a gift tax or having to file gift tax paperwork:
- Anything given to a spouse who is a U.S. citizen
- Anything given to a dependent
- Charitable donations
- Political donations
- Funds paid directly to educational institutions on behalf of someone else
- Funds paid directly to medical service or health insurance providers on behalf of someone else
There are, of course, a few exceptions to keep in mind. If your spouse is not a U.S. citizen, you can only give him or her $152,000 each year. Anything above that is subject to gift tax and counts against your lifetime limit.
Funds that cover educational expenses refer only to tuition. That does not include books, dorms or meal plans. You can skirt the gift tax by contributing to someone’s 529 college savings plan with a lump sum and then spreading it over five years for tax purposes. The IRS allows taxpayers to donate $75,000 into a 529 plan without paying tax or reducing the $11.4 million lifetime limit. The only caveat is that any additional gifts for the same recipient will count toward your lifetime limit.
Lastly, it’s important to note that charitable donations are not only exempt from gift tax, they may also be eligible as an itemized deduction on your individual income tax return.
How to Pay Gift Tax
The first step to paying gift tax is reporting your gift. Complete IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, on or before your tax filing deadline. Download the document, complete each relevant line and sign and date along the bottom. You then send the form in with the rest of your tax return.
You should complete Form 709 anytime you gift in excess of $15,000 – even if you’re within the $11.4 million lifetime limit. You’ll have to file a Form 709 each year you give a reportable gift, and each form should list all reportable gifts made during the calendar year.
If you live in Connecticut, you may also have to file a state gift tax return. It is the only state that has its own gift tax as of 2019. In most cases, you can file a gift tax return on your own. If your transfers are large or complicated, consider finding a financial professional. CPAs and tax attorneys should be comfortable and confident with gift tax limits, rules and paperwork.
The Bottom Line
The IRS allows every taxpayer is gift up to $15,000 to an individual recipient in one year. There is no limit to the number of recipients you can give a gift to. There is also a lifetime exemption of $11.4 million. Even if you gift someone more than $15,000 in one year, you will not have to pay any gift taxes unless you go over that lifetime gift tax limit. You will still need to report gifts over the annual exclusion to the IRS via Form 709. The IRS will lower your remaining lifetime exclusion over time and then use that amount to determine how much of your estate you need to pay estate tax on.
Tips for Getting Through Tax Season
- If you’re gifting large enough amounts that you’re flirting with the gift tax, then you should probably be working with a financial advisor who can manage and invest your wealth. If you don’t already have an advisor, you can find one today with SmartAsset’s free advisor matching tool. Simply answer a few questions about your financial situation and goals, and the program will pair you with up to three financial advisors in your area.
- Any charitable donations that you make are tax deductible. As you plan for your taxes, it’s important to keep track of your potential deductions throughout the year. They could save you money if you make deductions worth more than the standard deduction.
- One way to maximize your deductions is to use the right tax filing service. Two of the best filing services, H&R Block and TurboTax, both offer tools to help you maximize your deductions. And while both services are easy-to-use, certain taxpayers may prefer one over the other. Here’s a breakdown of H&R Block vs. TurboTax to help you decide which is best for you.
Photo credit: ©iStock.com/donald_gruener, ©iStock.com/Goran13, ©iStock.com/YinYang