Gift Tax

So a few weeks ago, someone posed the following question to us regarding gift giving:

Can you please explain how the gift-tax system works and what its rationale is? I know that if I give someone a gift below a certain amount, then I don’t have to pay gift tax. But what happens if I give over that amount? My contribution was made with after-tax money. Why do I have to pay a gift tax? It just feels like I am being double taxed.

We thought it was a good question, so let’s explain what the so-called gift tax is really all about.

Lifetime Exclusion
Our current tax system essentially treats the transfer of wealth the same whether the transfer was made during the donor’s lifetime or posthumously.  However, the IRS grants taxpayers a life time exclusion (also called the lifetime exemption) that allows them to give away $5,340,000 (in 2014) at either stage or a combination of the two.  Thus, a taxpayer can give up to this amount during their lifetime or after death without either the recipient or the donor owing any tax on that transfer.

Annual Exclusion
A common source of misunderstanding surrounding gift tax has to do with how the lifetime exclusion amount relates to the annual exclusion.  The annual exclusion allows a taxpayer to give $14,000 (in 2014) to another person per year without it counting against the lifetime exemption.  You and your spouse can combine this annual exclusion to double the size of the gift to a done if you would like (up to $28,000).  So what happens when you give more than the above amounts?  Well, you then have to deduct the difference against your $5,340,000 lifetime exclusion.  Just how do you do this?

You, or your estate if the taxpayer is deceased, must file Form 709 United States Gift Tax Return by the same date that your Individual Tax Return is due (April 15th).  You will owe no tax on your gifts unless you have already given more than the lifetime exclusion. Once you file Form 709, the government notes what your remaining exemption is. The same process is followed every time you exceed the annual exclusion limit (e.g. $14,000). Then at your death, any bequest beyond the remaining limit is subject to taxation.  Thus, it’s not until you reach this point that your gift is subject to double taxation so to speak.

If you want more information on the gift tax and reporting, check out this nifty little IRS site
on the topic.  Still have questions?  Why not give us a call or shoot us an email via our contact information below and we’d be happy to chat with you.