Will your gifts be subject to the Gift Tax?

Gift taxes are part of the federal system of transfer taxes.  In establishing laws that taxes wealth when it transfers from one person to another, Congress was reflecting a bias against inherited wealth that probably dates back to anti-royalty thinking of the American Revolution.

A gift occurs when someone freely and voluntarily transfers property from themselves to another for less than market value.  In estate planning terms we typically talk about lifetime gifts to heirs.  There can often be tax advantages in making gifts to children or other heirs during your lifetime. 

No Impact on Income Taxes

A gift has no impact with regard to income taxes. A gift is not taxable income. Recipients of gifts received them income tax-free.  Likewise, gifts are not deducted from the donor’s income taxes. Sometimes my clients are confused when they hear that they can make gifts to their children “tax-free”.  The reference is to the Annual Exclusion from gift tax.  

There is, however, no gift tax deduction, and the giver cannot deduct gifts from their income taxes.

Gift Tax Exclusion

The law provides an annual exclusion from gift taxes.  This is the amount a donor can give to a beneficiary each year with no tax.  In 2011 the gift tax exclusion is $13,000 per recipient.  The annual exclusion is indexed to inflation and goes up from time to time.

Example: If you gave each of your children a gift of $10,000 you do not have to file a gift tax return and no tax is owed.  That is because you have given less than the annual exclusion amount of $13,000.

One can also increase the tax-free nature of the gift by bundling to multiple recipients.

Example: If you gave a gift to both your son and his wife, your daughter-in-law, these would count as separate gifts.  Consequently, the total amount of the gift can be up to $26,000 and still qualify under the annual exclusion.

Do I Have To File A Gift Tax Return?

In 2011 the annual exclusion amount for gift taxes is $13,000.  A married couple can now make split gifts of up to $26,000 without incurring any gift tax liability.

In considering filing tax returns most people don't think of filing Form 709, the Federal Gift Tax Return.  But the filing of that return is required in instances when you and your spouse make a split gift greater than the annual exclusion amount of $13,000.

There is no tax, but the return is necessary for you to declare the split gift.

Always discuss significant gifts with your income tax professional.

Gifts in Excess of the Annual Exclusion Amount

If the gift exceeds the total amount of the annual exclusion in a single year, you’ll need to file a return. However, no tax may be due.

You’re allowed to contribute $1 million in your lifetime in excess of the annual exclusion. So, for purposes of avoiding taxation, $1,000,000 is the true gift tax limit. Gifts in excess of the annual exclusion are also deducted from the $5 million exemption to the estate tax.

Example: A father gives his daughter a gift of $15,000. The first $13,000 passes to the daughter under the annual exclusion. The father must file a return reporting the $2000 gift made in excess of the annual exclusion amount. The $2000 is deducted from the total lifetime gift exemption of $1 million and from the $5 million estate tax exemption.

Gift Tax Rate

If you manage to exceed your $1,000,000 lifetime exemption, your gifts can be taxed at a maximum rate of 35%. This gift tax rate is set to remain unchanged though 2012.

Impact of a Gift on Capital Gains Basis

When you make the gift of property other than cash you are also making a gift of its current status for capital gains purposes. The recipient needs to know the donor’s cost basis and how long he has held the property. This can be a very significant issue when one makes large gifts such as real estate.

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