Clearing up the confusion over the Gift Tax Law, updated for 2018

There are many confusing tax laws, but the one that seems to generate the most misunderstanding is the gift tax law.

Many are aware that gifts can be made up to $15,000 in 2018, (this amount is periodically adjusted for inflation) with no tax consequences – but beyond that it’s fuzzy. A client asked me if she would have to pay tax on a $100,000 gift her parents were planning to give her to buy a house. The answer is no.

Here’s the low-down on the gift tax law:

1. Anyone can make gifts of up to $15,000 (in 2018) to as many people as they choose without any tax implications. This gift is called an “annual exclusion gift”- meaning the gift is tax-free for the giver and the receiver.

In each following year,  the donor can start all over again giving gifts up to the annual exclusion amount to as many people as they choose. The gift can be either cash or goods. The gift does not have to be to a family member, it can be to anyone the giver chooses. In addition, married couples can each give $15,000 a year, so your grandchild could receive $30,000 from you and your spouse in a given year.

2. If a donor exceeds the annual exclusion ($15,000 in 2018) to any one person, that is also a tax-free event – unless the gifts go over the generous lifetime estate and gift tax exemption of $11.18 million per person.  A minor annoyance:  Form 709 – United States Gift Tax Return – must be filed with that year’s tax return. But NO tax is due.

3. The recipient of said gifts (of any amount) does not pay tax on the money ever, at all.

If a gift tax return (Form 709) is required, it will be due on April 15 of the year following the year in which the gift was made.

Let’s step back and define what a gift is for IRS purposes:  It’s something that is given and nothing is received in return. It is complete as a gift. Loans are not gifts.

What are some of the reasons people give gifts?

  1. They are generous and kind.
  2. They want to help a loved one with expenses such as a down payment on a house,
    education costs, or a vacation.
  3. They are very wealthy and want to reduce the size of their estate and therefore, estate taxes.
  4. They know they won’t spend all their money during their lifetime and want to
    share it with their loved ones before they die.

Examples:

1. You and your spouse decide to give $15,000 each to your four grown children for Christmas. The total gift amount is $120,000. No tax is due and no gift return is filed.

2. The Brown’s gives $200,000 to their daughter Sally, to assist in the purchase of her first home. A gift tax return (Form 709)  for $170,000 ($200,000 –  $15,000 x 2) would be filed with that year’s tax return.  In subsequent years, any gifts the Browns’ give over the exclusion amount will be added to the $170,000.

How the estate and gift tax are tied together:

Let’s say the Brown’s, over their lifetime, gift $1,000,000 in gifts over the annual exclusion amount. When they die, the $1,000,000 will be subtracted from their lifetime estate and gift tax exemption – $11.8 x 2 =  $22.36 million – $1 million  = $21.36 million or $10.68 million each.

It’s obvious that very few but the most wealthy will exceed the estate and gift tax exemption, and in consequence few people pay estate or gift tax. This wasn’t always so. The basic exclusion amount (or applicable exclusion amount in years prior to 2011)  was $1,500,000 (2004-2005), $2,000,000 (2006-2008), $3,500,000 (2009), $5,000,000 (2010-2011), $5,120,000 (2012), $5,250,000 (2013), $5,340,000 (2014), $5,430,000 (2015), $5,450,000 (2016), and $5,490,000 (2017).

Spousal gifts and portability

Spouses fall under different rules when it comes to gifting and estate or gift tax. The unlimited marital deduction allows you to gift any amount of money or property to your spouse without incurring either the federal gift tax or a state gift tax if you live in a state that imposes one.

In addition, in 2013, Congress passed the American Tax Relief Act of 2012 (“ATRA”). One of the key provisions of ATRA is to make permanent the portability of the applicable exclusion amount between spouses, which was enacted by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Portability allows the first spouse to die to transfer his/her unused estate tax applicable exclusion amount to the surviving spouse, who can then use it for his/her gift or estate tax purposes. The key is to be sure to file an estate tax return at the first spouse’s death to elect portability.

Gifts made directly for education or medical expenses qualify for exclusion.

Payments that you make on someone’s behalf for qualified tuition or medical expenses do not count towards the annual limit for gift tax purposes. This means that you can pay for a child’s tuition in the amount of let’s say $20,000 and if it is paid directly to the institution, you can still give that child $15,000 that year.

However, your payment(s) must be made directly to a qualifying educational organization or medical care provider in order to qualify for the exclusion.

In the case of 529 contributions, these gifts are considered part of the annual gift exclusion.  So you can give $15,000 a year to a 529 plan (or you can also give 5 years in one year or $70,000 and use up 5 years of the exclusion amount).  Note, these contributions are not made directly to an institution.

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