Making gifts to family and friends is part of the holiday tradition for millions of Americans. Unfortunately, paying tax is also a big part of the American tradition. So, as you pick out presents for your loved ones this holiday season, do you really need to worry about possibly owing gift tax in 2014? Let's take a look at the rules governing the gift tax to see if you should be concerned.
What you need to know about gift taxes
The gift tax in the U.S. is part of a unified system of taxation that covers both bequests made after death and gifts made during one's lifetime. Tax rates of up to 40% apply to certain gifts, with the tax owed by the person making the gift, rather than whoever receives the gift.
But Uncle Sam isn't interested in collecting tax on every little Secret Santa gift that you make. That's why lawmakers set what's known as an annual exclusion amount for the gift tax. For 2013 and 2014, that amount is $14,000. That means you can make gifts to anyone up to that amount without having to file a gift-tax return. That covers the vast majority of gifts that ordinary Americans give.
Even if you make gifts above this amount, though, you almost certainly won't have to write out an actual check to pay gift tax in 2014. For one thing, the $14,000 limit is a per-person amount. So if you make a gift to a married couple, you essentially get double the $14,000 limit. Moreover, if you're married and you and your spouse make the gift jointly, you can also take advantage of doubling the amount. With careful planning, you can make a huge number of $14,000 gifts to various people -- a tactic that many wealthy families use every year for estate-planning purposes.
Finally, even if you do go over the annual exclusion amount, you also have a lifetime exemption from estate and gift tax. For 2013, that amount is $5.25 million, with an increase to $5.34 million slated for 2014. Any gift you make that exceeds excluded amounts counts against this lifetime exemption, but until you use all of it, you won't actually owe any gift tax.
Special rules for special gifts
Fortunately, some gifts aren't subject to these limits, letting you give as much as you want for certain purposes. The most commonly used provision is the unlimited marital deduction for gift tax, which lets you make gifts to your spouse of any amount without having to file a gift tax return.
But other gift tax exemptions also exist. Payments for educational expenses aren't subject to gift tax, allowing parents, grandparents, or others to pay tuition for students without incurring gift tax liability. But to qualify you have to make the gift directly to the school in question. If you instead give money to the student, you might have to pay gift tax, even if the student then turns around and pays the school. Similarly, unlimited exemptions for medical expenses also exist, but again, you have to pay the hospital, doctor, or other medical professional directly, rather than giving it to the patient.
Don't panic about gift taxes
As scary as this sounds, most people never have to worry about paying gift tax. Unless you make truly huge gifts that don't qualify for these favorable provisions, then you won't have an encounter with the gift tax in 2014.
Be smart about your taxes
Avoiding unnecessary gift tax in 2014 is just one way you can help reduce your bill to Uncle Sam. In our brand-new special report "How You Can Fight Back Against Higher Taxes," The Motley Fool's tax experts run through what to watch out for in doing your tax planning this year. With its concrete advice on how to cut taxes for decades to come, you won't want to miss out. Click here to get your copy today -- it's absolutely free.