Not too long ago, a member of the ChooseFI Facebook group asked how much cash they could give to their parents without having to pay taxes on it.
Now, for those of you who don't know, this is known as a Gift Tax.
If you gift large sums of money, investments (savings bonds, etc.), or items like cars, you could be stuck paying a Gift Tax on it at the end of the year.
Here's everything you need to know to help you better understand the Gift Tax and how to avoid it.
What Is The Gift Tax?
The technical definition of a gift given by the IRS is: “Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.”
Now that’s a mouthful. What all that means is when you give someone a gift that has a large monetary value (anything over $15,000 for 2019), and you expect nothing in return, you’re giving them a gift.
Whatever amount is over $15,000 is what you, the donor will be potentially taxed on. This tax is the Gift Tax.
Who Does (And Doesn’t) Need To Pay The Gift Tax?
As stated above, anyone who gives a gift with a value of over $15,000 must pay a Gift Tax. The recipient of the gift is not responsible for paying the tax.
But there are special circumstances where you won’t have to pay taxes. The following five types of gifts require no tax:
- Gifts that are not more than the annual exclusion for the calendar year ($15,000 in 2019).
- Tuition or medical expenses you pay for someone (the educational and medical exclusions).
- Gifts to your spouse.
- Given to a political organization for its use.
- Gifts to charitable organizations.
What Is The Lifetime Gift Tax Exemption?
Even if you gift someone a gift of over $15,000 this year, you may not need to pay taxes on it. The Lifetime Gift Tax Exemption allows you to give away $11.4 million in your lifetime without paying taxes on the gift. However, this limit is shared with your estate taxes. Basically, you can give away $11.4 million (in 2019). Either during your life or upon your death and pay no gift or estate taxes.
Let's look at an example:
Let's say you give your child $20,000. $15,000 is tax-free based on the annual exclusion. You can then put the remaining $5,000 towards your lifetime exemption. Doing this will reduce your taxes now but may increase your estate taxes upon your death.
Also, note that the limit is per person and per recipient. This means if you are married you and your spouse can each give away $15,000 per year to as many different people as you want. So you and your spouse can each give your daughter $15,000. And you both can also give your son $15,000 each for a grand total of $60,000 given away to your two kids.
Those gifts would all fall under the annual exclusion and not affect your estate taxes upon your death.
One thing to note is that unless changes are made the Lifetime Gift Tax Exemption and estate taxes will revert to $5.5 million per person in 2025.
Why Does The Gift Tax Exist?
At this point, you’re probably pretty peeved by the fact that you have to pay taxes on the money that you want to give away.
How Much Is The Gift Tax?
Unfortunately, the Gift Tax can be hefty. It ranges from 18% – 40% depending on the value of the gift.
For a complete look, here’s a table that summarizes the Gift Tax rates.
|$0 – $10,000||18%
|$10,001 – $20,000||20%
|$20,001 – $40,000||22%
|$40,001 – $60,000||24%
|$60,001 – $80,000||26%
|$80,001 – $100,000||28%
|$100,001 – $150,000||30%
|$150,001 – $250,000||32%
|$250,001 – $500,000||34%
|$500,001 – $750,000||37%
|$750,001 – $1,000,000||39%
How Do I Pay My Gift Tax?
If you do make a gift over $15,000, you’ll need file tax Form 709 with the IRS.
Even if you want to apply the $15,000 to your lifetime exemption, you’ll need to file the form so the IRS can keep a running total of the amounts you’re counting toward your lifetime exemption.
Can I Deduct The Tax On My Tax Return?
Typically, no. Unless your gifts are charitable donations (and therefore not subject to Gift Tax), you cannot deduct them on your income tax return.
How To Avoid The Gift Tax
There’s a simple answer to this: Don’t give gifts over $15,000 in one year. But, if you want to, there are a few strategies so you can avoid the Gift Tax.
Use Your Combined Giving Power With Your Spouse
As a married couple, you can each give $15,000 to a single person (so $30,000 total in a year).
So, if you need to give someone a gift that is larger than $15,000, get together with your spouse, and both give a gift.
If you need to gift more than $30,000 combined, your only other option to avoid the Gift Tax would be to spread out the amount of money you give over a few years.
Pay Tuition Directly To The University
If you want to pay college tuition for your grandchild and you write a check directly to them, you’ll have to pay Gift Tax. If you make the check out to the university itself, this won’t be subject to Gift Tax.
This same standard applies to gifting money to pay medical bills. Make the check out to the hospital, not your family member.
Unless you are extremely wealthy the gift tax is not likely to be something of concern. Anyone who is looking at estate taxes after 2025 may have a little more to worry about, however. Estates over $5.5 million will be subject taxes unless changes are made to the tax law.
If you plan to have over $5 million, you may want to consider giving your fortune away before your death in $15,000 chunks (or $30,000 if you are married). Doing so will reduce or eliminate estate taxes upon your death.