Gift Tax

WHAT IS GIFT TAX?

The Internal Revenue Code (“IRC”) imposes a gift tax on transfers of assets to an individual other than a spouse or dependent when such transfers exceed a specified amount – often referred to as an annual exclusion amount. Similar to the estate tax applicable exclusion covered here, the annual exclusion applied to gifts can increase yearly, but only in increments of $1,000.

A typical scenario that gives rise to a gift tax occurs when a donor (the individual making the gift) transfers or gifts to a donee (the individual receiving the gift) without receiving compensation of equal value in return.

When a gift is made over the then-current annual exclusion, the donor is responsible for filing a gift tax return and potentially paying any gift tax due.

 

ANNUAL EXCLUSION:

The annual exclusion amount which a doner may make to any single donee for the current tax year (2023) is $17,000. This means that a donor will incur no gift tax so long as the donor does not give more than $17,000 to any single individual this year; and can give to multiple individuals. Married couples may give double the current annual exclusion amount (in this case, $34,000) before they must file a gift tax return.

Suppose a donor exceeds the annual exclusion amount and files a gift tax return. In that case, the donor may still avoid paying a gift tax if the donor has not exceeded the lifetime applicable exclusion amount, currently at $12.92 million.

 

WHAT ARE THE GIFT TAX RATES, AND HOW ARE THEY CALCULATED?

As of this article’s publication, the Internal Revenue Service requires a donor exceeding $17,000 in combined gifts made during this calendar year to any single donee to file a gift tax return.

What makes the taxability of such a gift challenging to determine is that gifts made during your lifetime above the annual exclusion amount will be subject to a gift tax only when your lifetime applicable exclusion amount is exhausted. In other words, your estate will not have to pay a gift tax unless you exceed your lifetime exclusion amount.

Gift tax rates range from 18% to 40% on taxable transfers.

To illustrate the impact of the annual exclusion amount, consider an individual who wishes to make a $30,000 gift to each of their four children annually. Also, imagine that this donor has used up their lifetime applicable exclusion amount, so everything above the annual exclusion amount is taxed. The current annual exclusion amount is $17,000 per child, and the amount of the gift in excess is taxable; in this case, $13,000 ($30,000 – $17,000 = $13,000) for each child is taxable.

Under this scenario, and assuming this individual is married, both spouses can gift up to $17,000 annually, allowing this same $30,000 gift to each child to pass annually, gift tax free with no offset to either donor’s lifetime applicable exclusion amount.

 

WHAT COUNTS AS A GIFT?

Any transfer of cash or property to a non-spouse or dependent in which the donor does not receive something of equal value qualifies as a gift.

Not all transfers of cash or property are considered gifts under the IRC, which include annual gifts within applicable limits, gifts to spouses, some payments for medical expenses, some payments for educational expenses, and some gifts made to political organizations.

Gifting large sums of money to family often will inadvertently trigger a need to file a gift tax return. An example is providing a child with $50,000 as a downpayment on a first-time home purchase or providing a child with $25,000 for a wedding.

Lending money to a friend and later deciding to forgive the debt may qualify as a gift, as does an interest-free loan.

Joint bank accounts, particularly adding a child as a joint owner to a piece of real estate, may qualify as a gift under the IRC. Transfers of real estate creating a joint tenancy in this fashion can also create cost-basis issues when the real estate is eventually sold.

Similarly, selling an asset below market value may qualify as a gift. Consider a parent wishing to sell a child a $500,000 piece of real estate for $350,000. While this is entirely permissible, the parent is, in effect, making a $150,000 gift which the parent must report under the IRC.

 

IN SUMMARY:

The gift tax is a federal levy imposed on a donor who gives another individual a sum of assets without receiving an equal value in exchange. Although complicated, there exist numerous ways to avoid paying a gift tax and numerous strategies to make gift tax free bequests to loved ones.