‘Tis the season for gift giving. But is the gift taxable? Or deductible?
The gift tax. I’m sure you’ve heard about it. I receive a lot of calls about it. But do you know what it’s all about?
What is a gift? A gift is any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.
In other words, if you give away something of value and don’t receive an equal value in return, you’ve given a gift.
(So far, so good, right?)
Why is there a gift tax? There is a gift tax to prevent those with a sizable estate from giving away their property before death and escaping the estate tax. You could say it acts as a ‘backstop’ to the estate tax.
Why gift? Several reasons are:
• Assisting someone in immediate financial need
• Providing financial security for the recipient
• Giving the recipient experience in handling money
• Seeing the recipient enjoy the gift
• Taking advantage of the annual exclusion
• Paying a gift tax now to reduce overall taxes
• Giving tax-advantaged gifts to minors
Most gifts are not subject to the gift tax, and don’t even have to be reported. Here are a few rules to keep in mind.
1. The annual exclusion: you are allowed an annual gift tax exclusion of $13,000 to as many people as you want (including your accountant), without any reporting or tax consequences. A married couple’s exclusion is doubled to $26,000. This includes your aunt, uncle, brother, sister, next door neighbor, – anybody.
2. The gift tax return, IRS form 706, does not need to be filed if the value is less than the annual exclusion of $13,000 per person.
3. Gifts are not taxable to, or reportable by, the person receiving your gift. Any number of people can give you up to the $13,000 limit each, and you will have no tax consequences. No liability whatsoever.
4. Gifts are not deductible by the giver, unless to a charity. Non-charity gifts do not reduce your taxable income because they are not deductible on your tax return.
5. There is no gift tax for:
. Gifts less than the annual exclusion of $13,000
. Tuition or medical expenses you pay for someone (directly to the institution). (Does not have to be family member.)
(Grandparents paying college for grandchildren are common.)
. Gifts to your spouse.
. Gifts to a political organization (for the organization’s use).
. Gifts to a charity.
6. If you sell something at less than its value or make an interest-free or reduced-interest loan, you may be making a gift.
7. Gift Splitting. A married couple may give a gift of up to $26,000 to a third person by considering it being made as half by each. A gift tax return needs to be filed because the total is over the $13,000 limit, but there is no tax. (By contrast, each may give a $13,000 gift separately without the need to file the gift tax return.)
8. Lifetime Credit: Even if you exceed the annual $13,000 per person limit, there is no tax until you reach the lifetime credit of $5 million.
Your tax basis, or cost, in the property you receive as a gift is the same as it was in the hands of the person giving you the gift, and you are considered to have owned the property for as long as the person giving you the gift owned it. (I’m not talking about an inheritance here, only the receipt of a gift from a living person. Inherited property is always considered long-term.)
As an example, let’s assume that your father gives you a piece of property in 2011. He paid $1,000 for it thirty years ago, and today the property is worth $50,000. If you sell the property this year, you will have a long-term capital gain of $49,000 (Sale price $50,000 minus cost $1,000). The property is considered to be long-term because you take on the purchase date of thirty years ago.
In general, the long-term/short-term holding period of property received as a gift is added to your holding period.
Why Knowing the Basis is so Important:
Sale at a Profit: If the stock is sold at a gain, the profit is the difference between the basis of the stock in the hands of the giver, and the proceeds received.
Example: Now let’s say that your father gave you stock which cost him $10,000, but when he gifted it you, the market value was $6,000. If you sold it for $12,000, you would have a gain of $2,000 (Your father’s cost which now became your basis, $10,000, less the selling price of $12,000.)
Sale at a Loss: If, when the stock was given as a gift, the market value was less than the basis of the stock in the hands of the giver, the loss is the difference between the lower market value and the proceeds.
Example: Now let’s say that you sell the same stock for $4,000. Is the loss $6,000 (Cost of $10,000 less selling price of $4,000)? No. It’s only $2,000. Tax law says it’s the market value at the time of the gift, $6,000, less the selling price of $4,000.
Sale at no Gain or Loss: There is no profit or loss if the stock is sold at a price between the basis of the stock in the hands of the giver, and the market value on the date of the gift.
Example: If the stock is sold at a price between the market value at the time of the gift, $6,000, and your father’s basis, $10,000, there is no gain or loss.
One more point: If a gift tax was paid when the stock was given, the basis of the stock is increased by the amount of the gift tax.
Planning Tip: If you’re considering the sale of property (like rental real estate or a vacation home), gifting this property to family members can reduce the income tax liability for the family as a whole. Caution: If, after the sale, you control the sales proceeds or have the use of them, the IRS may claim that the gift was never actually took place.
Planning Tip: In addition to reducing the size of your estate, another major tax advantage of making a gift is the removal of future appreciation in the property’s value from your estate. Suppose that you give stocks worth $50,000 to your children now. If you die in 10 years and the stock is worth $130,000, your estate will escape tax on the $80,000 appreciation even though you may have to pay a gift tax.
There’s a lot more in this area that is covered here, but this is a basic summary. You’ll need to contact an expert is this field before you begin any gifting strategies. You may want to check out IRS Publication 950.
But at least now, you are ready for your first quiz, aren’t you??
And don’t forget, in the words of Arthur Godfrey, ‘I’m proud to be paying taxes in the United States. The only thing is, I could be just as proud for half the money.’