Although you should keep a record of the gifts you make in your lifetime, it should not be a big deal because the U.S. federal gift tax rules track most gifts. Consider giving a significant amount of property or money prior to your owed taxes.
The logic behind the gift taxes is to ensure people do not give their assets before their death to avoid paying the estate tax after their death. However, you can avoid paying the gift taxes by taking advantage of the lifetime exemption and annual exclusion.
What are the qualifications of a gift?
According to the Internal Revenue Service (IRS), any transfer of property or cash is a gift if the donor does not get something of the same value. For example, when you give your friend some cash and he/she is not supposed to return the cash, then the cash is a gift. Likewise, if you sell your home property for $100,000 when the actual value is $200,000, then you give the buyer $100,000.
However, this is according to the definition of “fair market value” by the IRS. Certainly, this is in terms of cash. When it comes to property like a house, the IRS states the fair market value is the expected pay for the house, if the seller and the buyer were not under pressure to transact.
From the above, the definition of a gift by the IRS varies where you least expect it. For example, when you offer a loan without interest to your friend and then later forgive that debt, the IRS considers it as a gift. Likewise, when you add your adult child as a joint owner of your bank account, then you get a taxable gift.
Which gifts do not qualify for the gift tax?
Some gifts do not fall under the gift tax category. For example, if a father pays the medical expenses or tuition bills of his son directly to the institution, he will not incur the gift tax.
In addition, there exist unlimited marital deductions that apply to all gifts offered by a U.S citizen to his/her U.S citizen spouse. Although with a few exceptions, you are free to give your spouse unlimited gifts without paying the gift tax. Nevertheless, you can only give a max of $155,000 either in property or cash to a recipient spouse who is a non-U.S. citizen. This limit is for inflation purposes.
Donations to some political organizations and qualified charitable organizations do not incur the gift tax.
Amounts that are Exempted and Excluded from Gift Tax
Lifetime Gift Tax Exemption
The lifetime exemption allows you to give someone over $15,000 per year without paying the gift taxes. The lifetime exemption is the total tax-free amount you can give in your entire lifetime. This year (2020), the amount stands at $11.58 million.
This amount is a collective cap added to the annual exclusion. For example, when you give your child a lump sum of $40,000, then $20,000 of the amount falls under the annual exclusion and it is tax-free, while you can choose the remaining $20,000 under the lifetime exemption cover.
However, you should use Form 709, U.S Gift Tax Return to report to the IRS about your gifts under the annual exclusion.
The gift tax and the federal estate tax shares the lifetime exemption. Therefore, your lifetime gifts lower your remaining exemption amount to later protect the taxation of your estate.
In short, the IRS sums together the gifts you have made when alive and those you make from your estate after your death. Under the unified tax credit, the estate tax and the gift tax share the $11.58 million exemption.
Once you die and your estate settles, the IRS adds up all your annual overages and then applies the sum to your lifetime exemption. In case the sum of your excess gifts and the value of your estate is more than $11.58 million, the current tax rate for estates is 40%.
Similarly, if your gifts exceed your annual gift tax exclusion by $1million in your lifetime, it means you have $10.58million remaining to protect your estate from taxes after your death.
To avoid the gift tax from counting against your lifetime exemption, ensure you pay your taxes on gifts by filing the gift tax return.
Exclusion of the Annual Gift Tax
The annual gift tax exclusion allows you to offer tax-free gifts to a specific amount each year per person. This year (2020), the amount stands at $15,000. However, it changes and increases by $1,000, although not each year.
“Per person” is the keyword in the annual gift tax exclusion. For example, if you want to give a $30,000 down payment to your daughter and her husband who want to buy a home, you can avoid the gift tax. To do so, give a total of $15,000 to each of them that year. The good thing is that spending the money on one thing is not a concern to the IRS.
The other benefit is that married spouses are each allocated a $15,000 annual gift tax exclusion. Therefore, you and your wife can give your daughter and her spouse $15,000 each, which brings the sum to a total of $60,000.
Nevertheless, married couples cannot file joint gift tax returns. Instead, each spouse should make a separate tax file after making any taxable gifts. Alternatively, spouses can “split” their gifts. Splitting of gifts enables you to enjoy the benefit of the annual gift tax exclusion.
The Unique 529 Plan Contributions Rule
Any contribution to the 529 plan for college savings is a gift to that future student. Nevertheless, there is a unique rule that allows you to make a huge contribution and then spread the lump-sum amount over five years due to gift tax. For example, you can jump-start your child’s 529 college savings account with a $75,000 contribution this year. Your wife/ husband is also free to do the same. After that, you can now spread that gift over 5 years (2020-2025) to avoid incurring the gift tax and reducing your lifetime gift tax exemption. This means if you or your spouse make extra gifts to that child (same recipient) within the 5 years, you will reduce your $ 11.58-lifetime exemption.
You can pay the estate or gift taxes when you make gifts under these categories:
- Gifts to cover the tuition expenses of another person, provided you make the payments directly to the learning institution. However, expenses for supplies, books, board, and room are not part of the exception. To cover these costs, make sure you make the gift under the annual exclusion, and straight to the student.
- All gifts made to any IRS approved charities.
- Gifts to cover the medical expenses of another person, provided you make the payments straight to the hospital.
- All gifts to a U.S. citizen spouse.
Taxes on gifts can become a brain teaser if you do not know much about tax calculations. Do get in touch with us for assistance related to tax filing, tax planning, or investments. Visit ubos.pro for more information.