In this post, I discuss how the gifts you make may result in a large tax bill, courtesy of the federal gift tax, and how this backstops the estate tax.
The gift tax, as the name suggests, is a tax on certain gifts. It serves as a backstop to the estate tax, preventing wealthy estates from escaping the estate tax by gifting away property prior to death. The tax is imposed upon the giver of the gift, rather than the recipient, and utilizes the same rates as the estate tax with a top rate of 40%.
Gifts Exempt from the Gift Tax
Certain types of gifts are generally exempt from the gift tax. These include gifts to charity, gifts to political organizations, and gifts to one’s spouse. In addition, paying someone’s tuition or medical expenses is generally not considered a taxable gift, so long as the giver pays the charging institution—such as a university or hospital—directly.
In addition, annual gifts to any one person of $14,000—adjusted annually for inflation—or less are not subject to the tax. Married couples may combine their annual exclusions, thereby allowing them to give away $28,000 per person per year. Since this exclusion applies to each recipient, giving 10 people $14,000 each per year would not incur a tax liability, but giving one person $140,000 probably would.
Both the estate and gift tax share the unified credit, which is currently $2,045,800. (The unified credit is derived from the lifetime exclusion amount that is currently $5,250,000, though this amount is adjusted annually for inflation.) This means that you can gift away $5,250,000—not counting the annual exclusion amount, which does not deplete the unified credit—over the course of your lifetime without owing any gift tax. Any amount of the unified credit that you utilize for gift tax purposes, however, will be unavailable at death to apply toward the estate tax. Therefore, formulating a sound strategy to take advantage of the unified credit at the appropriate time is an important part of any large estate’s planning.
Gifts and the Income Tax
Recipients of gifts do not have to report the value of the gifts on their income tax returns. Determining what constitutes a gift, however, is important for both income and gift tax purposes and can be quite complex. The Supreme Court held in Commissioner of Internal Revenue v. LoBue that a gift is a transfer that demonstrates a “detached and disinterested generosity.” This definition leaves much to be desired.
It should be noted, however, that an employer generally cannot give an employee a gift beyond a de minimus amount. In the past, some employers would “gift” an employee a special bonus, such as a new car, so that the employee could exclude the value of that bonus from their income tax return. Unsurprisingly, the government disallowed such a scheme.