When generous Aunt Betty slips you a $5,000 check on your birthday, do you have to pay taxes on her cash gift? And when you send an annual donation to your favorite charity or alma mater, does anybody pay taxes on that gift? The answer in both cases is no, although as silly as it sounds, gift givers must pay taxes on some gifts.
Luckily, recipients never pay a gift tax and the limits at which the gift tax kicks in for givers are high enough that most people will never pay taxes on their gifts. But as your wealth grows over time, the gift tax may start to affect you. Let’s answer your burning questions about the gift tax.
What constitutes a gift?
A gift is when someone gives something of value (cash, property, the use of property, etc.) to someone else without expecting anything in return. Additionally, if you were to sell something you own for considerably less than its value, then this could be considered a gift. For example, if you own a car worth $15,000 and you want to sell it to your brother for $10,000 as a favor to him, the $5,000 difference could be considered a gift.
It’s important to note that support from your parents or guardians while they can still claim you as a dependent does not constitute a gift. Your parents can give you all the money in the world while they are claiming you on their taxes and it will never be taxed as a gift. However, as soon as you lose dependency eligibility, their support may be taxed as a gift.
Annual gift tax limitations
Before you start tallying up every dime you gave to your niece as a present, don’t worry about it. Most presents to friends and family will fall below the annual threshold for taxable gifts.
In 2015 and 2016, a taxpayer can give up to $14,000 per person per year without being taxed on the gift. For example, this year you could give Friend A $14,000, Friend B $14,000, and your sister $14,000 and not be taxed on your gifts.
However, if you gave $14,000 to Friend A, but $15,000 to Friend B, you would then be taxed on that $1,000 gift to Friend B. (So, as you can see, unless you’re regularly throwing around five-figure gifts, the gift tax limitations will exclude the gifts most of us give and receive).
Lifetime gift tax limits
For 2016, the IRS has set a lifetime estate and gift tax exemption of $5.45 million. What this means is that an individual can leave heirs (either in an estate and/or through gifts while he or she is alive) up to $5.45 million before that money is subject to federal tax.
Gift tax exclusion
Luckily, the IRS understands that some gifts are necessary and therefore excluded from the gift tax. There are unlimited exclusions (they are never taxable) for the following gifts:
- Charitable gifts
- Gifts to political organizations
- Gifts between spouses
- Educational and medical gifts (see explanation below)
To receive the exclusion for the educational and medical gifts, you must give this gift directly to the medical or educational institution. For example, if your aunt is having surgery that will cost $50,000 and you want to provide your aunt the money for the surgery, you must give the $50,000 directly to the hospital. You may not give this money to your aunt or you will be subject to gift tax on the amount that exceeds $14,000. This same rule applies for educational gifts (for example, if your friend or brother was attending college).
Also, note that charitable gifts may be eligible to be claimed as an itemized deduction on your individual income tax return.
How to avoid gift tax
The best way to avoid the gift tax is pretty self-explanatory: Do not give gifts that exceed $14,000 per person per year.
Also, another way for parents to avoid the gift tax is to remember that each parent is entitled to their own individual $14,000 exclusion. This means that your mother and father could each give you $14,000 this year — for a total of $28,000 — without being taxed on that gift. This is referred to as “gift-splitting.”
Although the estate tax (the taxation of an individual’s assets after they die) is an entirely different subject, it ties in well with the gift tax. Many people who want to avoid paying the lofty estate tax when they die can slowly give their assets and money as gifts as they get older. Many people choose to start giving gifts up to the exclusion amount to their heirs as they reach old age. This makes a lot of sense and is a smart and legal way to avoid or mitigate the estate tax when someone dies.
Don’t be afraid to give or receive!
Overall, the gift tax does not affect very many people in their teens or twenties. So don’t worry about that $20 you gave to you brother for his last birthday — it won’t be taxed (under current tax law, anyway). The same is true if you receive a larger gift from a generous relative … as long as it’s less than $14,000 per year. The gift tax can be easily avoided throughout life just by following certain limitations set out by the government.
Now that you have all the facts about the gift tax, don’t be afraid to get generous this year!