The end of the year is the season of giving, and where there are gifts, there's also the potential for gift tax. The U.S. tax laws impose gift tax on gifts of cash or property whose value exceeds annual limits, with rates as high as 40%. However, most people never have to think about what the gift tax is, because a combination of annual exclusions and a lifetime exemption prevents taxpayers from owing any actual tax currently. Below, you'll learn more about the rules and regulations that apply to gifts and whether you'll owe tax.
How the gift tax works
The U.S. uses a tax system that combines gifts made during one's lifetime with bequests left in one's estate at death. The person who gives the gift is the one who may owe gift tax.
However, lawmakers didn't want to put the IRS in charge of policing every minor gift that people made. That's why there's an annual exclusion amount under which you don't have to pay any gift tax. For 2016 and 2017, you can give up to $14,000 per year without any gift tax liability. In addition, you can make as many of those $14,000 gifts to different people as you want, because it's a per-person limit, not a total limit. For instance, if you have three children and want to make maximum gifts to each of them, you could give a total of $42,000 -- $14,000 each to all three.
So what happens if you give someone $15,000? The $1,000 in excess of the annual exclusion amount is theoretically subject to gift tax, and you'll have to file a gift tax return. However, most taxpayers also have access to what's known as the lifetime exemption. For 2016, that amount is $5.47 million, and it goes up to $5.49 million in 2017. So if this were your first such gift, then the taxable amount of the gift would use up $1,000 of your lifetime exemption, leaving you with $5.489 million to use for the remainder of your life and in calculating estate taxes after your death. You wouldn't actually owe any out-of-pocket tax until you used up all of your lifetime exemption amount, which is rare for any but the wealthiest Americans.
Some gifts are unlimited
The gift tax rules also acknowledge several types of gifts for which higher limits or no limits at all apply. There are four categories that are most frequently used:
- The marital deduction allows most spouses to make unlimited gifts to each other without any gift or estate tax liability.
- The charitable deduction exempts any charitable gifts from the gift tax rules.
- You can make payments for educational expenses on behalf of a student, and as long as you pay the money directly to the educational institution in question, you can avoid gift tax on the full amount. This provision is not available if you write a check to the student and the student then uses that money on educational expenses.
- Similarly, you can make payments to cover medical expenses for someone else without owing gift tax. However, those payments must be made directly to the doctor, hospital, or other medical services provider. If the money goes through the person owing the medical expenses, it won't qualify, and you could potentially have to pay gift tax on any portion that exceeds annual exclusion amounts.
If you have a taxable gift
Finally, the only situation in which you have to file a gift tax return with the IRS on Form 709 is if your total gifts to any one person exceed the annual exclusion amount of $14,000. That keeps most people from having to file returns at all. For more on Form 709 and how to fill it out, this online IRS information about gift taxes can be helpful.
So as the holiday season continues, remember that for most people, the gift tax shouldn't be a concern. Only those making large gifts will need to pay closer attention to the gift tax rules and the ins and outs of filing returns with the IRS.
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