Avoiding the Pesky Gift Tax

A lot of people come into my office with questions about the gift tax. It’s a weird one – you have to pay tax on gifts you give people? Really? That seems dumb.

Like any tax, the gift tax has a long history and, like a handful of taxes, was created during the Great Depression of the 1920s and 1930s to generate revenue for the suffering federal government. The feds were finding that an estate tax (the tax on your assets upon death) was not enough – if possible, dying people were simply giving their estate away right before they died, which would avoid the tax on their estate. So, the clever result to recapture those lost taxes was the gift tax. This way, the feds would get the money on the transfer whether by gift or by death.

The general rule with the gift tax is that you pay a certain percentage in tax for every gift you give. The rates vary from 18% to 40%, depending on the size of the gift. The good news is that there are two major exceptions to this tax:

1. The Annual Exclusion. You can give $15,000 to an individual every year without paying an estate tax on that gift. This number is current for 2018 (up from $14,000 in 2017) and is subject to change annually. Good advice tells you to report the gift even if it’s below $15,000 to acknowledge that it happened and was below the annual exclusion, but oftentimes people don’t report gifts under the annual exclusion. You and your spouse can give one of your kids a total of $30,000 by splitting the gift, meaning each of you gives that kid $15,000. In fact, you and your spouse can collectively give all five of your kids $30,000 if you want! Each gift would be under the annual exclusion for each spouse and would not create a taxable event. In that example, you two would have transferred $150,000 tax-free

2. The Lifetime Gift Tax Exemption. In addition to the annual exclusion, everyone has their own, personal lifetime gift tax exemption that equals the amount of the applicable estate tax exemption. I will reserve the estate tax discussion for another blog, but it’s good to know the lifetime gift tax exemption equals the federal estate tax exemption. Thanks to the controversial tax bill passed in late 2017, the current lifetime gift tax exemption/federal estate tax exemption is $11,200,000 per person, which means a couple can gift up to $22,400,000 in their lifetime. So . . . not a huge problem for most people.If you use part of your lifetime gift tax exemption (i.e., you give more than $15,000 to an individual in a year), you should work with a CPA to properly report that gift so the IRS is aware of your gift and the use of your lifetime gift tax exemption. Without getting into too much detail here, a large gift can have unintended tax consequences.

So – there is a federal gift tax but you don’t have to pay it unless you are making some serious gifts. However, you can’t just assume the IRS knows about your use of the exceptions, so you do need to make sure you’re reporting your gifts.

The great news for Washington residents is that there is no state gift tax so the planning we do only applies to the federal gift tax!