Talking Taxes: Gift Tax

Today, we will continue our three-part Talking Taxes series with a discussion of the federal gift tax.  If you missed our first post discussing the estate tax, click here.

As I did last week, I want to offer two disclaimers.  The first is that I am not a CPA or an accountant.  I’m here to offer just basic information, but highly recommend that you consult with your attorney and tax professional for further advice or clarification.  Second, there has been a lot of talk from Washington, DC, about potential changes to some of these rules.  The posts in this Talking Taxes series will explain the law as it currently is written and applied, but everyone needs to be sure to pay attention to any changes that could be forthcoming.

What is it?  The gift tax is a federal tax on asset transfers for less than fair market value.  In other words, if you give an asset to someone, or if you sell an asset and less than full consideration is paid, it is considered a gift subject to the gift tax.

Who pays it?  Generally, the donor (person giving the gift) is responsible for the gift tax if it is owed.

How is the gift tax calculated?  The gift tax rates range between 18% – 40% depending on the value of the taxable gift.  However, most people will not actually pay that amount due to the annual exclusion and the the lifetime exclusion.

What is the annual exclusion?  The annual exclusion is an amount below which, the gift tax does not apply. Each year, the IRS sets an annual exclusion amount, and any gifts from one person to another falling below that exclusion are not subject to the gift tax.  For 2021, the annual exclusion is $15,000. Importantly, the annual exclusion applies to each donee (gift recipient). This means that a person may give any other individual up to $15,000 in 2021 without gift tax implications.  For example, a mother could give each of her four sons and each of their wives $15,000 this year without being subject to the gift tax even though the total amount gifted was $120,000.

What is the lifetime exclusion?  The lifetime exclusion is a concept we talked about in the estate tax blog post.  For 2021, every person has an $11.7 million lifetime exemption. If a person makes a gift this year to another person worth more than $15,000, they are required to file a gift tax return.  The gift giver will not, however, automatically owe the gift tax.  Instead, the amount over the annual exclusion will be deducted from your lifetime exemption.  For example, in 2021, if you give your child a gift of $25,000, this is considered a taxable gift because it exceeds the annual exclusion.  Because of that, you will have to file a gift tax return, and the $10,000 that exceeds the annual exclusion will be deducted from your lifetime exclusion.  No gift tax will actually be paid until the lifetime exclusion has been exhausted.

When is the gift tax return due? Anyone who makes a taxable gift (one exceeding the $15,000 annual exclusion) must file a gift tax return (Form 709) by the normal tax filing deadline the year after the gift is made.  Note, this gift tax return is required for any taxable gift, even if the lifetime exclusion has not been exhausted and even if no taxes are actually owed.

What exemptions exist?  There are certain gifts excluded from the gift tax.

First, as discussed above, any gift worth less than the annual exclusion is not subject to the gift tax.

Second, there are educational and medical exclusions that may be available for a person paying school tuition or medical expenses for another person.  There are particular requirements here, including that the person giving the gift must pay the school or medical facility directly.  If this may be applicable to you, contact your accountant to ensure all requirements are met.

Third, any gifts made to one’s spouse are excluded from gift tax liability.

Fourth, gifts to political organizations are excluded.

Finally, gifts given to qualifying charities are deductible from the value of the gift made.

What can a person do to avoid gift tax liability?  There can be options to consider in order to avoid gift tax liability.  Before making gifts over the annual exclusion, a person should visit with his or her attorney, account, and/or tax professional to discuss other strategies.

How can a person’s gift tax impact their estate tax liability?  This is a key point for people to understand.  If a person gives taxable gifts during his or her lifetime, that directly impacts the amount of his or her lifetime exclusion.  Keep in mind, it is the value of that lifetime exclusion that dictates whether a person owed the estate tax or not.  This is a connection that may not seem obvious, but could have major unintended consequences.  For example, say that Pat has an estate worth $10 million.  He does not worry about the estate tax, because he is below the $11.7 million lifetime exemption.  However, if Pat gifted land worth $2,015,000, he could have an estate tax problem.  This is because Pat made a taxable gift that was $2 million over the annual exclusion.  Thus, his lifetime exemption will be reduced by that $2 million, leaving him with $9.7 million.  Because his estate is worth more than the lifetime exemption, he will owe estate tax.

Where can I find additional information? For additional information on the estate tax, check out this podcast episode I did with Kitt Tovar from the Iowa State Center for Agriculture Law and Taxation.   Additionally, the Internal Revenue Service actually has some useful explanations on their website, including overviews and Frequently Asked Questions.

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