If you make a gift that exceeds the annual gift exclusion of $14,000 in 2016 or 2017, it may be subject to the gift tax. However, there is a lifetime exemption amount of $5.45 million in 2016 and $5.49 million in 2017 that must be exceeded before gifted cash or property is subject to tax.
What is the gift tax in the United States?
In the United States, certain gifts are subject to tax, including cash gifts as well as property. If a gift is taxable, it may be subject to gift tax rates of up to 40%.
However, the vast majority of Americans never have to pay the gift tax, even if they give a substantial sum of money, or valuable property, to other people because of two important rules.
The annual exclusion
As of 2017, the IRS allows a $14,000 annual exclusion amount when it comes to taxable gifts. In other words, if a gift of money or property is valued at $14,000 or less, it does not need to be reported to the IRS and no gift tax will need to be paid.
This exemption is per person, and is doubled for married couples to $28,000, which can make it quite useful in estate planning. To illustrate this point, let's say that you're married and have three children, all of whom are also married. You can give away up to $28,000 to each of those six people, tax-free, for a total of $168,000 per year that the IRS can't touch. This is a common strategy for reducing the taxable value of an estate.
The lifetime exemption
Speaking of the taxable value of an estate, it's important to mention that the gift tax and the estate tax systems in the United States are connected. Estate taxes are only assessed on estates valued at $5.45 million or more for the 2016 tax year, and $5.49 million or more for the 2017 tax year. These amounts are known as the lifetime exemption.
The lifetime exemption amount applies to gifts as well. After you reach the $14,000 annual exclusion, the excess reduces your lifetime exemption. There's no way of knowing what the lifetime exemption will be in the year you die, so the IRS keeps a running total of your taxable gifts each year (more on that later).
For example, we hope it's not the case, but for simplicity's sake let's say that you die in 2017. Over the years, you've given a total of $1 million in taxable gifts to family and friends. Therefore, the amount of your estate that is exempt from taxation is reduced from $5.49 million to $4.49 million.
Other exempt gifts
In addition to these non-taxable amounts, there are a few more exceptions to the gift tax. Here are four that are excluded from both the $14,000 annual exclusion amount and the lifetime exemption.
- Charitable gifts
- Gifts to a spouse who is a U.S. citizen (gifts to foreign spouses are subject to an annual $148,000 limit as of 2016)
- Educational gifts, although this applies to payments made directly to a qualified educational institution only, not to things like books and school supplies
- Medical expenses paid directly to the person providing the care
If you made a gift larger than $14,000 this year
Generally speaking, if you make a gift of $14,000 or more to any one person in a calendar year, you need to let the IRS know about it by filing IRS Form 709 with your taxes unless it qualifies for one of the other exceptions discussed in the previous section. However, unless the amount of the gift greater than the annual exclusion puts you over the lifetime exemption, no tax will be due on the gift. Instead, the taxable portion of the gift simply lowers your lifetime exclusion.
For example, let's say that you give $50,000 to your children to use as a down payment on a home. For simplicity's sake, we'll assume you're single. The first $14,000 of this gift is automatically excluded from taxation. The other $36,000 will count against the lifetime exemption, along with any other such gifts you've made, at the time of your death.
As you might imagine, most people don't even come close to the lifetime exemption when giving gifts. However, if you've given a whole lot of gifts in your lifetime and have already exceeded the current lifetime exemption amount, you'll have to pay the gift tax on any amounts you give beyond the annual exclusion.
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