Taxability of Gifts: Who Pays and How to Avoid Taxes
If you’ve decided to give a friend or family member a monetary gift, you’re probably doing so because you want to help them out — not hand them a tax liability. Fortunately, you need not worry. The IRS holds the gift giver liable for any taxes rather than the recipient. That’s if there is any tax due at all, and there often isn’t. Read on to learn the ins and outs you need to know about gift taxes.
What is the Gift Tax?
Your first job likely taught you a lot about life, including the fact that whenever you get money, the IRS usually gets some of it too. When you give someone else money and get nothing in return, or if you get something of much less value in return, the IRS considers the money a gift.
Technically, money given as a gift is taxable if it exceeds a certain amount, known as the annual gift tax exclusion. In reality, however, the gift tax is rarely an issue for anyone but the very wealthy. This is in part due to the annual gift tax exclusion and in part due to the lifetime gift tax exclusion.
What can be Excluded From Gifts?
When it comes to the gift tax, it’s important to know that there are several gifts that you can completely exclude. One such gift is one made to a spouse. Money given to a spouse is never a taxable gift if both spouses are United States citizens.
Gift taxes also become a non-issue when money is paid directly to an institution of higher learning or a medical institution. Let’s say, for example, that you decide to go back to college at 35, and your father wants to help you. If he pays tuition money directly to the school on your behalf, the IRS doesn’t count the money as a gift at all and the gift tax issue is avoided. The same is true if your friend decides she wants to help you pay a recent hospital bill. If she pays the hospital directly, the IRS is willing to turn a blind eye to the gift.
There is also an annual gift limit. If your gift stays below this limit, no one needs to worry about the gift tax at all. For 2022, the annual gift tax exclusion is $16,000. Be aware, however, that this exclusion is both per recipient and per person, which leaves a lot of wiggle room. But what, exactly, does it mean?
The per recipient rule means that each gift you make during the year can be up to $16,000 before you need to worry about the gift tax. If you have three children, you can give all three of them $16,000 without worrying about the gift tax. So long as any gits made to a specific individual don’t exceed $16,000, you can gift as many people as you like without paying any tax.
The gift tax exclusion also applies per person. Let’s say, for example, that your parents are still happily married. They decide they want to give you some money to put a down payment on a house. The annual gift exclusion applies to both of them. This means they can each give you $16,000 without the gift tax becoming an issue. The result is that you can actually get a cash gift from parents to the tune of $32,000 without gift tax worries since there are two of them.
The other exclusion to the gift tax is political organizations. Gifts made to these organizations are not tax-deductible, but they are free of any type of gift tax.
Who Pays the Gift Tax?
When gift tax is due, it is the gift giver who pays. If the gift is an inheritance, the deceased’s estate is the party that pays any relevant gift taxes. As previously stated, however, most people never pay a dime in gift tax, even if they’re very generous. This is due to the lifetime gift tax exclusion, which we’ll talk about next.
How the Lifetime Gift Tax Exclusion Works
This is where the gift tax law gets interesting. The gift tax is limited by two gift tax exclusions. The first, as we’ve explained, is the annual gift tax exclusion. For 2033, this amount is $16,000 per person and per recipient per year.
The second is the lifetime gift tax exclusion. As of 2021, this exclusion is $11.7 million. This means that over the course of your lifetime, you can give away up to $11.7 million dollars without paying any gift tax. Here’s how it works.
Let’s say you’re a single parent and you give your son a gift of $20,000. There is no gist tax due on the first $16,000 because of the annual gift tax exclusion. But something needs to be done about the remaining $4,000 of the gift, which is technically taxable.
To deal with this, you will file a special form with the IRS, on which you will report the $4,000 portion of the gift. This money is taxable, but you don’t have to pay the tax on it. Instead, you can apply the $4,000 toward your $11.7 million lifetime gift tax exclusion. This means that even though part of your gift was taxable, you don’t have to pay a dime of tax on it. In reality, the gift tax doesn’t become an issue unless your lifetime gifts, including any made by your estate, don’t exceed $11.7 million.
About Form 709
When a gift exceeds your annual exclusion, you need to report it to the IRS on Form 709. This form requires you to report the gifts you made and then helps you calculate which gifts are taxable and which are not. This form also tracks your previous taxable gift-giving, providing a way for you and the IRS to know how much of your lifetime gift tax exclusion you’ve used.
Are Gifts Tax-Deductible?
Don’t let the gift tax throw you for a loop when making charitable donations. The IRS distinguishes between the two. Donations are “gifts” that you give to an IRS-approved nonprofit organization, and they are never taxable. They are deductible, however. Other gifts are taxable and not tax-deductible. This includes gifts to friends family members, or others.
To simplify things, the IRS maintains a list of charities and organizations that they consider qualified nonprofit organizations. If someone you give money to is on the list, it’s deductible. If they’re not, the money you gave is not tax-deductible.
Remember Your State
And now for one last piece of gift tax advice: Don’t forget your state. Not all states have a gift tax, but others do. Even if you’re free and clear of the IRS, your state may expect you to pay a gift or estate tax. Connecticut and Minnesota, for example, both have gift taxes. Iowa, Kentucky, and Nebraska are just a few of the states with an inheritance tax. Always remember to check the rules in your state along with IRS regulations.
We’ve just thrown a lot of tax information at you and much of it likely sounds like conflicting advice. So what’s the bottom line? Are gifts taxable? Yes, they are. But thanks to lifetime and annual exclusions, you probably won’t ever have to actually pay that tax unless you’re quite wealthy.
If you’re feeling a little overwhelmed by it all, don’t worry. The tax professionals at Picnic Tax are happy to answer your questions and get it all sorted out for you. We have an excellent understanding of the tax law coupled with the ability to break it all down into manageable chunks. We can help you plan ways to minimize any gift tax and help you file all the right paperwork to keep your gifts legal. We’re ready to get started whenever you are.