The Motley Fool Previous Page Basic Gift Tax Issues

By Roy Lewis

Many people are curious about the "gift tax exclusion" and how it really works. Some still believe that a gift is deductible by the person making the gift (the donor), and taxable to the person receiving the gift (the donee). This is absolutely not true. Gifts (not to be confused with charitable contributions, which have their own separate rules) are neither deductible by the donor, nor taxable to the donee.

Each person is allowed to gift a specific amount that will not trigger any gift or estate tax issues. This specific amount is called the gift tax exclusion.

Why gift money?

Gifting money can be a very effective way to transfer substantial amounts from your estate, free from gift and estate taxes, to your children or other loved ones. This technique of estate tax planning can drastically reduce your taxable estate after your death, and could thereby reduce your associated estate taxes.

The amount of the annual gift exclusion, which is currently $10,000, has been adjusted for inflation after 1998. However, the amount of the exclusion is always rounded to the next lowest multiple of $1,000, so the $10,000 amount won't increase to $11,000 until the inflation adjustment is at least 10%. At current levels of inflation, it may be several years before the exclusion rises to $11,000. In fact, this $10,000 limitation is in effect for 2000 and 2001.

The exclusion covers gifts an individual gives to each recipient each year. Thus, a taxpayer with three children can transfer a total of $30,000 ($10,000 each) to them every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $10,000 per recipient, the exclusion covers the first $10,000 and the excess is taxable. Further, even taxable gifts may result in no gift tax liability thanks to the unified gift/estate credit (which we'll discuss below).

At this point, it should be noted that gifts made by a donor to his spouse are gift-tax-free under separate marital deduction rules. So, if you are considering making a gift of property or cash to your spouse, understand that the annual $10,000 exclusion will not apply to you.

Gift-splitting by married taxpayers:
If the donor of the gift is married, gifts made during a year can be treated as a "split" between the husband and wife, even if the cash or gift property is actually given by only one of them. By gift-splitting, therefore, up to $20,000 a year can be transferred to each recipient by a married couple because their two annual exclusions are available.

A married couple with three married children can transfer a total of $120,000 each year to their children and children-in-law ($20,000 for each of the six separate recipients).

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return(s) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Since more than $10,000 is being transferred by a spouse, a gift tax return(s) will have to be filed, even if the $20,000 exclusion covers the gifts. So, be aware that if you elect gift-splitting, you'll need to file Form 709 (Annual Gift Tax Return) if more than $10,000 is being given to a singl