Understanding Gift Tax
As a financial planner, I often get asked about gifting money. Not your typical $20 in a birthday card - we’re talking about helping children or grandchildren buy a house or helping friends with bills, for example.
When you want to gift a significant sum of money to someone, you should be aware that there are some rules around it. Plus, it can affect both yours and the recipient’s tax situations.
Gift Categories
Some gifts are fairly common, like vehicles upon the passing of your driving test. However, the parent typically still owns the vehicle since minors can’t own property. When you gift someone a large sum of money, it can be subject to gift tax.
There are several different “categories” of cash gifts, some of which fall outside of gift taxation. For example, gifting to your spouse is unlimited as long as it qualifies under marital deduction.
The same applies to charitable donations that qualify under the charitable donation deduction, political donations, and tuition payments made direct to an education institution.
Finally, paying for medical and healthcare expenses on behalf of another person are also allowed when paid directly. So, it is recommended to pay directly to a medical or educational institution rather than giving the cash to a friend or family member - this avoids gift tax.
Annual Exclusion Amount
In 2021, you have an annual allowance of $15,000. However, this applies per person you donate to, which means that there is no limit on the amount of people you can give to every single year.
If you time it right, it means that you could actually fund quite a large purchase. For example, let’s say your child and their spouse are buying a new house and you would like to contribute. You could gift both of them $15,000 in December of one year, then another $15,000 the following January. It means that they could receive up to $60,000 as a couple in just two months (or less!).
Lifetime Exclusion
In 2021, each individual has a lifetime exclusion of $11.7 million dollars. This means that over the course of your life, you are allowed to gift up to $11.7 million away to other people without incurring gift tax.
However, by 2025 this is likely to fall back to around $5.5 million dollars. Therefore, it makes sense for wealthy individuals to begin gifting now (if intended) in order to make the most of the allowance.
Filing a Gift Tax Return
Even though you are eligible for the lifetime exclusion amount, you may still have to file a Gift Tax return. This occurs when you exceed the annual limit, and doesn’t mean that you’ll necessarily owe any tax. It is simply a declaration.
Filing a 709 form informs the IRS of what to deduct from your lifetime exclusion.
For example, you may gift your child & their spouse $100,000 towards a house down payment. As we have already discussed, the limit per year for a married couple is $30,000. Therefore, you’d be declaring $70,000 worth of cash gifts and this would be deducted from the remaining balance on your lifetime exclusion.
Since estate tax and gift tax are closely linked, there are a number of laws in place to prevent tax fraud by those receiving an inheritance. So if you’d like to discuss how to make the most of cash gifts without impacting your child(s) inheritance, schedule a call with me to discuss it.