The holidays are coming up, and most people are starting to think about gift-giving for the season. Yet what many people don't realize is that technically, gifts you give for birthdays, holiday festivities, weddings, or just everyday occasions are potentially subject to gift tax from the IRS. In fact, it's only because of one provision known as the annual gift tax exclusion that most people don't have to deal with filing gift tax returns year in and year out. In 2018, the annual gift tax exclusion is slated to go up to $15,000. While that might be well out of the price range for most people, those who have major estate planning issues will welcome the added flexibility compared to 2017's annual gift tax exclusion amount of $14,000.
Why gift tax is so rare
Most people never have to worry about actually paying gift tax because of two provisions of the tax code. The annual gift tax exclusion is the more important of these, because people take advantage of it all the time and it relieves you of having to file any paperwork or do any other cumbersome accounting.
With the annual gift tax exclusion, you're allowed to give money or property with up to $15,000 for 2018 without having to file a gift tax return or pay any gift tax. The $15,000 amount is the maximum you can give to any one person, but you can make multiple $15,000 gifts to different people and still get an exclusion for each.
The annual gift tax exclusion is indexed for inflation. However, the amount is rounded to the next lower multiple of $1,000. As a result, the exclusion was stuck at $14,000 for several years before finally climbing to $15,000 for 2018.
Gifts to last a lifetime
In addition to the annual exclusion, you also have a lifetime gift tax exclusion that you can tap into. For 2018, that amount will be $5.6 million. If you make gifts in any given year above the $15,000 annual exclusion amount, then you still don't have to pay gift tax until you use up the full $5.6 million lifetime exclusion amount.
However, the problem with going above the annual exclusion is that you have to file a gift tax return to claim your lifetime exclusion. That requires completing Form 709 and sending it to the IRS. Moreover, once you've made gifts that require using the lifetime exclusion, you'll have to keep track of that used-up amount for subsequent gifts, and your estate will have to take it into account after your death for estate tax purposes.
To see how this works, say that you make a $35,000 gift to your child in 2018. The first $15,000 is eligible for the annual exclusion. The remaining $20,000 requires using your lifetime exclusion. If this is the first time you've used it, then you'll have $5.58 million left in your lifetime exclusion for use on future gifts.
Are all gifts taxable?
To make things more complicated, there are some types of gifts that go untaxed no matter how large they are. Spouses can generally make gifts of unlimited amounts to each other, reflecting the financial bond that most married couples have. Also, if you pay tuition on a student's behalf or medical bills for someone else, you can do so without any gift tax consequences -- as long as you make payments directly to the provider of those services rather than to the loved one who incurs the charges.
It's good news that the annual gift tax exclusion is going up to $15,000, because it will make it even rarer that anyone ever has to pay much attention to the specter of gift taxes. For those who have the financial wherewithal to make large gifts, having an extra $1,000 in gift-making capacity per person compared to 2017 could make smart estate planning strategies even more valuable.