If you give people a lot of money or property, you might have to pay a federal gift tax. But most gifts are not subject to the gift tax. For instance, you can give up to the annual exclusion amount ($14,000 in 2013) to any number of people every year, without facing any gift taxes. Recipients generally never owe income tax on the gifts.
In addition to the annual gift amount, your can give a total of up to $5.25 million starting in 2013 in your lifetime before you start owing the gift tax. If you give $16,000 each to ten people in 2013, for example, you’d use up $20,000 of your $5.25 million lifetime tax-free limit—ten times the $2,000 by which your $16,000 gifts exceed the $14,000 per-person annual gift-free amount for 2013.
The federal gift tax exists for one reason: to prevent citizens from avoiding the federal estate tax by giving away their money before they die.
The gift tax is perhaps the most misunderstood of all taxes. When it comes into play, this tax is owed by the giver of the gift, not the recipient. You probably have never paid it and probably will never have to. The law completely ignores gifts of up to $14,000 per person, per year, that you give to any number of individuals. (You and your spouse together can give up to $28,000 per person, per year to any number of individuals.)
If you have 1,000 friends on whom you wish to bestow $14,000 each, you can give away $14 million a year without even having to fill out a federal gift-tax form. That $14 million would be out of your estate for good. But if you made the $14 million in bequests via your will, the money would be part of your taxable estate and, depending on when you died, might trigger a large estate tax bill.
Your estate is the total value of all of your assets, less any debts, at the time you die. The new rules for 2013 will tax estates over $5.25 million at rates as high as 40%. That $5.25 million is an exclusionmeaning the first $5.25 million of your estate does not get taxed.
So why not give all of your property to your heirs before you die and avoid any estate tax that might apply? Clever, but the government is ahead of you. As noted above, you can move a lot of money out of your estate using the annual gift tax exclusion. Go beyond that, though, and you begin to eat into the exclusion that offsets the bill on the first $5.25 million of lifetime gifts. Go beyond the $5.25 million and you’ll have to pay the gift tax—at rates that mirror the individual income tax, up to 40% in 2013.
As you consider making gifts, keep in mind that very different rules determine the tax basis of property someone receives by gift versus receives by inheritance. For example, if your son inherits your property, his tax basis would be the fair market value of the property on the date you die. That means all appreciation during your lifetime becomes tax-free.
However, if he receives the property as a gift from you, his tax basis is whatever your tax basis was. That means he’ll owe tax on appreciation during your life, just like you would have if you sold the asset yourself. The rule that “steps up” basis to date of death value for inherited assets saves heirs billions of dollars every year.
Your mother has a house with a tax basis of $60,000. The fair market value of the house is now $300,000. If your mother gives you the house as a gift, your tax basis would be $60,000. If you inherited the house after your mother’s death in 2013, the tax basis would be $300,000, its fair market value on the date of her death. What difference does this make? If you sell the house for $310,000 shortly after you got it:
- Your gain on the sale is $250,000 ($310,000 minus $60,000) if you got the house as a gift.
- Your gain on the sale is $10,000 ($310,000 minus $300,000) if you got the house as an inheritance.
For tax purposes, a gift is a transfer of property for less than its full value. In other words, if you aren’t paid back, at least not fully, it’s a gift.
In 2013, you can give a lifetime total of $5.25 million in taxable gifts (that exceed the annual tax-free limit) without triggering the gift tax. Beyond the $5.25 million level, you would actually have to pay the gift tax.
Here are some gifts that are not considered “taxable gifts” and, therefore, do not count as part of your $5.25 million lifetime total.
- Present-interest gift of $14,000 in 2013. “Present-interest” means that the person receiving the gift has an unrestricted right to use or enjoy the gift immediately. In 2013 you could give amounts up to $14,000 to each person, gifting as many different people as you want, without triggering the gift tax.
- Charitable gifts
- Gifts to a spouse who is a U.S. citizen. Gifts to foreign spouses are subject to an annual limit of $143,000 in 2013. This amount is indexed for inflation and can change each year.
If you give an amount up to $14,000 to each child each year, your gifts do not count toward the $5.25 million of gifts you are allowed to give in a lifetime before triggering the gift tax. But what counts as a gift to a minor?
- Gifts made outright to the minor
- Gifts made through a custodial account such as that under the Uniform Gifts to Minors Act (UGMA), the Revised Uniform Gifts to Minors Act, or the Uniform Transfers to Minors Act (UTMA)
Note: One disadvantage of using custodial accounts is that the minor must receive the funds at maturity, as defined by state law (generally age 18 or 21), regardless of your wishes.
A parent’s support payments for a minor are not gifts if they are required as part of a legal obligation. They can be considered a gift if the payments are not legally required.
Example: A father pays for the living expenses of his adult daughter who is living in New York City trying to start a new career. These payments are considered a taxable gift if they exceed $14,000 during 2013. However, if his daughter were 17, the support payments would be considered part of his legal obligation to support her and, therefore, would not be considered gifts.
Giving a gift may earn you more than gratitude:
- Reduced estate taxes. Moving money out of your estate via lifetime gifts can pay off even if those gifts trigger the gift tax. How? By removing future appreciation on the asset from your estate. Say, for example, that you give your daughter real estate worth $5,264,000, using up your $14,000 exclusion and your entire $5,250,000 2013 lifetime gift exclusion. If the property is worth $7,014,000 when you die, that’s $1,750,000 less to be taxed in your estate.
- Reduced income taxes. If you give property that has a low tax basis (such as a rental house that has depreciated way below its fair market value), or property that generates a lot of taxable income, you may reduce income taxes paid within a family by shifting these assets to family members in lower tax brackets.
- Teaching your family to manage wealth. Giving family members assets now allows you to monitor their ability to handle their future inheritance.
- Reduces your net worth. You need to keep enough assets to care for yourself throughout a long or extended retirement or illness.
- The Kiddie Tax. Giving funds to children may subject them to the Kiddie Tax, which applies the parents’ tax rates to investment earnings of their children that exceed a certain amount. For 2013, the Kiddie Tax applies to investment income exceeding $2,000 for a child under age 19.
If you make a taxable gift, you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return, which is due April 15 of the following year. Even if you do not owe a gift tax because you have not reached the $5.25 million limit, you are still required to file this form if you made a gift that exceeds the $14,000 annual gift tax exclusion level. The IRS needs to keep a running tab of your lifetime exemption.
Example 1
In 2013, you give your son $15,000 to help him afford the down payment on his first house. This is a gift, not a loan. You must file a gift tax return and report that you used $1,000 ($15,000 minus the $14,000 annual exclusion) of your $5.25 million lifetime exemption.
Example 2
Same facts as above, except that you give your son $13,000 and your daughter-in-law $2,000 to help with the down payment on a house. Both gifts qualify for the annual exclusion. You do not need to file a gift tax return.
Example 3
Same facts in Example 1, but your spouse agrees to “split” the gift—basically this means he or she agrees to let you use part of his or her exclusion for the year. One spouse, for example, could give $28,000 to his son without triggering the gift tax if the other spouse agrees not to give the son any gift that year. Although no tax is due in this situation, the first spouse would be required to file a gift tax return indicating that the second spouse had agreed to split the gift.
Only individuals file Form 709: U. S. Gift (and Generation-Skipping Transfer) Tax Return—there’s no joint gift tax form. If a both spouses each make a taxable gift, each spouse has to file a Form 709.
On a gift tax return you report the fair market value of the gift on the date of the transfer, your tax basis (as donor) and the identity of the recipient. You should attach supplemental documents that support the valuation of the gift, such as financial statements in the case of a gift of stock in a closely-held corporation or appraisals for real estate.
If you sell property or family heirlooms to your child for full fair market value, you don’t have to file a gift tax return. But you may want to file one anyway to cover yourself in case the IRS later claims that the property was undervalued, and that the transaction was really a partial gift. Filing Form 709 begins the three-year statute of limitations for examination of the return. If you do not file a gift tax return, the IRS could question the valuation of the property at any time in the future.
For more information on the gift tax, see IRS Publication 559: Survivors, Executors, and Administrators.
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