Taxes can be confusing, and the gift tax is one of the most perplexing of the Internal Revenue Code.
What is the gift tax?
The gift tax is a federal tax on the transfer of money or property to another person while getting nothing (or less than full value) in return. Many people don't get hit with the gift tax, because the IRS generally doesn’t care about what you give away to other people unless that giving exceeds some lofty amounts. And even if it does, it might mean you just have to fill out some paperwork.
How much can you gift?
Two things keep the IRS’ hands out of most people's pockets: the $15,000 annual exclusion in 2020, and the $11.58 million lifetime exclusion in 2020. Stay below those and you can be generous under the radar. Go above, and you'll have to fill out a gift tax form when filing returns — but you will still likely avoid having to pay any gift tax at all.
How the annual gift tax exclusion works
- In 2020, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it.
- If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax. It just means you need to file IRS Form 709to disclose the gift.
- The annual exclusion is per recipient; it isn’t the sum total of all your gifts. That means, for example, that you can give $15,000 to your cousin, another $15,000 to a friend, another $15,000 to the neighbor, and so on all in the same year without having to file a gift tax return.
- The annual exclusion also is per person, which means that if you’re married, you and your spouse could give away a combined $30,000 a year to whomever without having to file a gift tax return.
- Gifts between spouses are unlimited and generally don’t trigger a gift tax return. Gifts to nonprofits are charitable donations, not gifts.
- The person receiving the gift doesn't need to report the gift.
How the lifetime gift tax exclusion works
- On top of the $15,000 annual exclusion, you get an $11.4 million lifetime exclusion (in 2020, that rises to $11.58 million). And because it’s per person, married couples can exclude double that in lifetime gifts. That comes in handy when you’re giving away more than $15,000.
- The gift tax return keeps track of the lifetime exemption. If you don't gift anything during your life, then you have your whole lifetime exemption to use against your estate when you die.
What is the gift tax rate?
If you’re lucky enough and generous enough to use up your exclusions, you may indeed have to pay the gift tax. The rates range from 18% to 40%, and the giver generally pays the tax. There are, of course, exceptions and special rules for calculating the tax.
Spoiling the grandkids with college money
- Let's say Grandma and Grandpa are going to give $60,000 and they are going to put it in a 529 plan for the grandchild for college. Grandma and Grandpa just triggered the gift tax exclusion because it's over $15,000 gifted in one year.
- A special rule allows gift givers to spread one-time gifts across five years’ worth of gift tax returns to preserve their lifetime gift exclusion. Again, a gift tax return should be filed to record this.
Springing for vacations, cars, etc.
- If you pay $50,000 for a child's wedding, or an expensive honeymoon, get ready to do some paperwork. Those kinds of things are actually gifts that people normally wouldn't even think about.
- If you’re paying tuition or medical bills, paying the school or hospital directly can help avoid the gift tax return requirement as these items are exclusions to the annual exclusion. Is it getting confusing yet?
Names on a non-spouse bank account
Let’s say you live by Grandma, so for convenience, she puts you on her bank account. Guess what just happened? If you're put as a joint owner on a bank account with somebody and you have the right to take the money out at any time, essentially Grandma has giving you a gift.
We love to talk about gifting strategies and to help our clients navigate the best strategies for their families. Please do call your advisor if you have any questions about taking advantage of the 2020 annual exclusion for before year end.