A gift is a transfer of property from a giver to a receiver without the giver receiving something of at least equal value in return. The federal government has the power to tax individuals who give gifts of money or property. Whenever federal gift tax is owed, the tax is always owed by the giver, never by the receiver. The amount of gift tax a giver may owe depends on the recipients of the gifts and the value of the assets gifted.
Gifts to some recipients are not subject to gift taxes, regardless of the value of the gifts. Gift taxes are not owed when the recipient is a U.S. citizen spouse, a charity, or a political organization. Gift taxes are also not owed when a giver pays someone else’s school tuition or medical expenses only if the giver makes payment directly to the educational or medical institution. For example, parents who contribute money to their child’s account for college tuition are making gifts to their child that may be taxable. Parents’ payments to support their minor children are not taxable gifts since they are legally required, but payments to their children for college education are not legally required and are therefore taxable gifts. If the recipient of a gift does not fit one of these exempt categories, the applicability of gift tax will depend on the value of the gifts.
The federal government allows individuals to give an amount each year that is not subject to gift taxes, known as the annual exclusion. The gift tax annual exclusion is $13,000 in 2010 and is set to increase with inflation in future years. The annual exclusion applies per giver, per receiver, per year. For example, a mother can give $13,000 annually to her son and $13,000 annually to her daughter without owing gift taxes. The father of those children can also give $13,000 annually to the same son and $13,000 annually to the same daughter without owing gift taxes. So in total, the mother and father can give a combined $52,000 annually to their two children, and all $52,000 is excluded from gift taxes. The number of people an individual can give the annual exclusion amount to each year is unlimited. An individual who gives $13,000 per year to 1,000 different people can give away $13,000,000 per year without owing any gift taxes! Individuals also have the option to give five years worth of annual exclusions all in one year. Rather than give $13,000 per year to a receiver for five years, the giver can give $65,000 in one year, as long as he or she does not give any additional gifts to that receiver during the next five years. If the giver makes any additional gift to the same receiver during that five year window, the giver will exceed the annual exclusion amount.
Gifts in excess of the annual exclusion amount count against the giver’s lifetime gift tax credit. As of 2010, individuals are exempt from paying the first $345,800 in gift taxes they may owe during their lifetimes. This $345,800 lifetime gift tax credit allows an individual to give up to $1,000,000 during his or her lifetime, in excess of the $13,000 annual exclusion, without owing any gift taxes. For example, a father gives his daughter $30,000 during 2010. The first $13,000 is excluded from gift tax, and the next $17,000 is a taxable gift. The gift tax on $17,000 is calculated to be $3,200. The father does not pay this $3,200 gift tax but rather uses $3,200 of his $345,800 lifetime gift tax credit. So his lifetime gift tax credit is reduced to $342,600 and will be further reduced by any gift tax he owes in future years. Once an individual has used up all $345,800 of his or her lifetime gift tax credit, he or she must then pay gift taxes on any future gifts given.
Individuals who want to minimize their potential federal estate taxes may want to limit their use of the lifetime gift tax credit. This is because the federal estate tax credit and the lifetime gift tax credit come from the same pool of available credits, together known as the unified credit. Every dollar an individual uses of his or her lifetime gift tax credit is one less dollar the individual has available for his or her estate tax credit. For 2010, there is no federal estate tax, but the federal estate tax is scheduled to return in 2011. Just like with the lifetime gift tax credit, the estate tax credit exempts individuals from paying the first dollars in estate taxes they may owe. For 2011, the federal estate tax credit is scheduled to be $345,800 which will allow individuals to die with an estate valued up to $1,000,000 without owing any federal estate taxes. However, if the individual uses some amount of his or her $345,800 lifetime gift tax credit, his or her $345,800 estate tax credit will be reduced by the amount of gift tax credit used.
Let’s look at an example that shows how the federal estate tax credit and the lifetime gift tax credit are interrelated, assuming a $345,800 credit for each. A gentleman gives $100,000 in excess of the annual exclusion amount during his lifetime. The gift tax on the $100,000 taxable gift is calculated to be $23,800. He does not pay the $23,800 gift tax, but instead he uses up $23,800 of his $345,800 lifetime gift tax credit. The gentleman later dies with a taxable estate of $1,000,000 of which estate taxes are calculated to be $345,800. If the gentleman had not used $23,800 of his lifetime gift tax credit, his estate would get to use all $345,800 of the estate tax credit and avoid paying any federal estate taxes. However, the $23,800 of previously used gift tax credit reduces his available estate tax credit to $322,000. As a result, his estate must pay the $23,800 of estate taxes that the remaining estate tax credit does not cover.
The future of federal estate taxes and gift taxes is extremely unclear at this point in time. The gift tax law may change, but most likely, a gift tax annual exclusion and a lifetime gift tax credit will remain in existence at some level. Most people’s gifts fall under the $13,000 annual exclusion amount, so gift taxes are never a concern for the majority; however, for individuals who give high value assets and have taxable estates, gift taxes are an important financial planning issue. Gift taxes and estate taxes may be unavoidable for some individuals, but with the appropriate financial planning, those individuals can minimize the gift taxes and estate taxes they ultimately have to pay.
Sources: TurboTax, IRS Publication 950, IRS Form 709
