One of the little joys in life is getting – or giving – a gift. There are all the traditional gift-giving events such as birthdays, holidays, new babies, weddings and the like that everyone has participated in by giving or receiving. But there is another kind of gift and there might be something attached to it – a gift tax.
For those gifts, we must look at it from the perspective of the Internal Revenue Service (IRS). To them, cash, property, or use of property is generally considered a gift when one person gives it to another without any expectation of something in return.
What Isn’t a gift?
The IRS considers nearly everything a gift with five exceptions:
- Gifts that are not more than the annual exclusion for the calendar year
- Tuition or medical expenses you pay for someone (the educational and medical exclusions)
- A gift to your spouse
- Contributions to a political organization
- Gifts to qualifying charities
Who pays the gift tax?
The person giving the gift pays the gift tax. For example, let’s say a friend gives you a check for $15,000 as a wedding present. You might think that this counts as income on which you and your new spouse will have to pay income taxes. But a gift is not subject to income tax. The gift tax, if one is owed, is paid by the giver of the gift, i.e. your friend.
Is there an annual or lifetime limit on gifts?
For tax year 2018, the annual exclusion per gift is $15,000 with a $5.6 million lifetime maximum.
Can I avoid paying gift taxes?
Yes, you can. However, you have to be strategic about the gifts and the timing of the gifts because of annual limitations. If your gift is no more than $15,000 for tax year 2018 and you haven’t exceeded the lifetime maximum of $5.6 million, you will not have to pay any gift tax. The IRS also states that if spouses own property together, they can each give $15,000 or a total of $30,000 to a third party without having to pay the gift tax. This is referred to as gift splitting.
Giving gifts of property or cash to your loved ones while you are still alive not only helps them out financially, but it also helps you to reduce the tax to be paid on your estate when you die.
Gift taxes and estate taxes are connected
There is a $5.6 million federal estate tax exemption for 2018. You can leave up to that amount to relatives or friends free of any federal estate tax. If you are married, your spouse is entitled to a separate $5.6 million exemption.
Making annual gifts up to the exclusion ($15,000 in 2018) is a good way to reduce your taxable estate without any negative side effects. Note that the annual limits change from time to time, so it is a good idea to check with a financial advisor, like me, before making any gifts.
What about 529 plan contributions?
Contributions to a 529 college savings plan are gifts to the future student. A special rule allows you to make a lump-sum contribution and spread it over five years for gift tax purposes. You can not make any additional gifts to the same recipient during those years without using part of your $5.6 million exemption.
You may need to file a gift tax return
If you make a gift in excess of the annual exclusion, you must file Form 709: U.S. Gift Tax Return. The return is required even if you don’t actually owe any gift tax because of the $5.6 million lifetime exemption.
All in all, giving gifts is still special, and can be financially beneficial, when it comes to your personal financial situation. Like many other aspects of retirement planning, You should plan for the disposition of your estate before the need arises.
It is always good to be prepared. Because not only does it give you peace of mind, but it puts your plans and wishes into action. Contact me with any questions or when you are ready to take a look at your tax plan for the future.
Dan