It’s officially the holiday shopping season. But be wary. Your Grinch neighbor, the IRS, is sitting high on the mountain, waiting to pounce. When money or items of value change hands, the IRS often wants a share, and believe it or not, it includes gift-giving.
The basic rules
A recipient of a gift does not pay income taxes on the gift. But the donor may pay gift or estate taxes. These taxes work together but are two different taxes, separate and apart from income taxes. A gift tax applies to gifts made during your lifetime, paid by the donor and not the recipient.
Estate tax applies to transfers at your death, paid by the decedent’s estate, not the recipient. There is one tax exemption for both these taxes. Currently, the exemption is $11.4 million, so you can give that amount away during your life or at your death, or some combination thereof, without gift or estate taxes.
Additionally, anyone can give another person a gift of up to $15,000 a year. That means spouses can together gift $30,000 per year. After that, the gift is subject to gift tax and you’ll need to use part of your exemption.
How it works
If you gift, for example, $25,000 to your adult child, $10,000 is a potentially taxable gift. You would need to file a gift tax return and claim a portion of your lifetime exemption, leaving you with $11,390,000 still to gift during your lifetime or at your death without taxes. An amount beyond that is taxed at 40%, and you or your estate pays that tax, not the recipient.
You may think that with an exemption that high you have nothing to worry about. — gift away! (Please add me to your list.) But beware that the exemption amount is scheduled to drop to about $5.4 million after 2025. Expect to see a lot of serious gifting by the wealthy in 2025 to use up the larger exemption that will disappear the following year.
What could go wrong?
There can be a lot of reasons to gift during your lifetime: your kid needs the money, you need to drop an asset from your estate, you’re downsizing and would like to see your child and grandchildren live in the family home. But beware that besides the potential for a gift tax, there’s an income tax issue, too.
Unlike property inherited due to death, gifted property keeps the same tax basis the donor had. Say you have stock you paid $25,000 for that is now worth $50,000. If the stock is given to your heirs, it would have an income tax basis of $50,000. If they sold the stock, they’d have no taxable gain. If you instead gift that stock during your lifetime, the recipient gets your same tax basis of $25,000. If they sell the stock, they will have a taxable gain of $25,000. This may work fine if the recipient is in a low tax bracket or is a tax-free charity. Just do the analysis with your advisors before making a gift of an appreciated asset. Timing is everything.
Other Gift Tax Exemptions
There are other gifts that can be made without incurring gift tax. Gifts to pay for someone else’s medical expenses or tuition, gifts to a spouse and gifts to charity do not incur gift tax no matter the amount and are not subject to the annual $15,000 limit. But again, be cautious. The Grinch is rubbing his green paws together.
A gift of tuition for all levels of education is not subject to gift tax, but the exemption, known as the Gift Tax Exclusion for Tuition, only applies if you make the payment directly to the institution and not the student and keep documentation. The exemption does not include gifts for housing, books, supplies, or meals. The gift may also affect the student’s eligibility for financial aid.
Payment of medical expenses is excluded from gift tax only if the bill is incurred for “the diagnosis, cure, mitigation, treatment, or prevention of disease” and is not covered by insurance.
Gifts between spouses are not subject to tax. But a gift from a spouse becomes the separate property of the recipient. You would not get half of it back if you divorce. (This is a Grinch of a different color, but relevant here.) Additional rules apply if your spouse is not a U.S. citizen.
Charitable gifts aren’t subject to gift tax, and you can get an income tax deduction if you itemize. But your deduction for charitable gifts is limited to 60% of your adjusted gross income, 30% in some cases.
Gifting to your loved ones or charity is, of course, a wonderful thing. My gift to you is simply to remind you that sometimes gifts need to be carefully planned out with professional advisors so it makes it to the Whos in your Whoville without the Grinch grabbing a chunk. The IRS is a mean one.
Teresa J. Rhyne is an attorney practicing in estate planning and trust administration in Riverside and Paso Robles. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I).” You can reach her at Teresa @trlawgroup.net.
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