A Guide to Gift Tax and Gift Tax Exemptions
Although many gifts are exempt from taxation, donors are sometimes responsible for reporting gifts on their IRS forms.
Gift taxes can apply to all types of tangible and intangible properties that have been transferred for free or at a substantial discount. Cash, real estate and stocks are common examples. Interest-free and reduced-interest loans may be subject to taxation too.
This guide will give you useful details about gift taxes, their exemptions and the most relevant IRS forms.
Defining Gifts for Tax Purposes
What are gifts in the eyes of government? Under US tax law, gifting occurs when one person transfers property to another for no cost or at a substantially reduced price. Additionally, there must be gift-giving intent, a notion that is somewhat difficult to define.
US courts have described gifts as the results of “detached and disinterested generosity”. This definition is expanded upon in Chapter 12, Subtitle B of the IRC or Internal Revenue Code.
Gifts That Are Not Tax Deductable
Which gifts are given without detachment or disinterest? One prominent example is gifts given at promotional events and on television shows. The giver is presumed to benefit in these situations. Another example is a gift that an employer gives to an employee – expenses for employee achievement awards are not tax deductible.
Giving to Family Members
Although gifts given to family members usually reflect “interest” in the layperson’s sense of the term, these gifts are generally exempt from taxation. The main rationale for this tax exemption is that keeping track of familial gifts given throughout the year would produce a cumbersome amount of paperwork for both taxpayers and the IRS.
Gift Taxes vs. Estate Taxes
People give valuable gifts to relatives and friends in order to reduce their estate tax burdens. Property owners can usually avoid subjecting valuables to the estate tax by transferring them before death. Unlike items given in wills, these are called ‘inter vivos’ gifts – these have lower tax rates than estate gifts. A limit is placed on gift taxes however, so that entire estates cannot be transferred without some form of taxation.
In addition, some gifts fall into a gray area. These are called ‘remainder interests’ – they are given within the three years preceding the donor’s death. Personalized tax guidance may be especially helpful to people filing the IRS forms related to these sections of their estates as they can get complex.
Non-Taxable Gifts
Many gifts that can be enjoyed immediately are not subject to federal taxation. Here are the main criteria:
Present vs. Future Interests
To be exempt from taxation, gifts must be for present interests. In other words, the recipient must be able to take ownership of the property immediately.
Annual Exclusion Gifts
Each taxpayer is currently permitted to transfer $13,000 tax-free to each recipient annually. Married couples may gift up to $26,000 per recipient. These gifts are called ‘Annual Exclusion Gifts’. They are not applied toward the lifetime gift tax exemption limit of $5,000,000 per person.
Other Tax-Exempt Gifts
In addition to giving up to $13,000 tax-free, a person can generally bestow the following without taxation:
· Gifts to qualifying charities.
· Gifts to political organizations.
· Gifts to a spouse.
· Payments for another’s tuition and medical expenses (these payments must be made directly to an educational or medical institution).
The IRS Forms Needed for Gift Taxes
When gifts do not qualify for exemption, gift taxes are paid with IRS Form 709. This form is also used to report generation-skipping transfer taxes, which are gifts of $1,000,000 or more. An overview of estate taxes and gift taxes is provided in IRS Publication 950.
Taxpayers handling estate taxes may need additional IRS forms, such as Form 1041 which is the U.S. Income Tax Return for Estates and Trusts, and Form 2848 for designating power of attorney.
Gratuitous and Partly Gratuitous Gifts
The IRS considers gifts to be either completely gratuitous or partially gratuitous. Gifts are completely gratuitous when donors receive no valuables in exchange for their property. When donors receive partial compensation, any gift tax that applies is adjusted accordingly. The partial compensation must be substantially less than the fair market value of the gift.
Tax Deductions for Gift Recipients
Recipients should not count gifts toward their taxable income. If the transferor demonstrated “detached and disinterested generosity,” then the gift is tax-deductible. However, income that’s derived from the gift (such as rental income from real estate) must be reported. Otherwise, both the donor and the recipient will be able to avoid paying taxes.
Conclusion
Gifting provides taxpayers with a way to reduce estate taxes while benefiting other individuals. Although many gifts are tax-exempt, annual and lifetime limits on untaxed gifting apply. The most commonly requested IRS forms in this area include Form 709, which is used for gift taxes and generation-skipping transfer taxes, plus Form 1041, which is used for estate taxes.
About the Author: Bob Goren is an accountant and independent advisor for filing IRS forms in the US.
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