All individuals who make a gift to another individual or entity that exceeds a certain amount must pay the federal gift tax. The donor, the person making the gift, is responsible for paying the gift tax, except in certain circumstances in which the IRS allows the recipient of the gift to pay the gift tax. Donors must report the gift by completing IRS Form 709 and attaching their payment by the same day as their income tax returns (April 15). Only two states – Connecticut and Tennessee – impose gift taxes at the state level in addition to the federal gift tax.
Nearly all property, tangible or intangible, can be considered a gift subject to the gift tax, such as stocks, jewelry, real estate, cars, art, and cash. Other common examples of gifts include zero interest loans and services. The gift tax is calculated based on the fair market value of the property at the time of transfer. However, gifts below a certain amount are exempt from taxation. Each year, the IRS adjusts this amount, known as the exclusion amount, for gifts. For 2011, the exclusion amount is $13,000 for individuals, which means if you make a gift valued at $13,000 or less, you do not have to pay the gift tax. Meanwhile, married couples can make combined gifts of up to $26,000 without being subject to the gift tax.
In addition to the exclusion amount discussed above, certain types of gifts are also exempt from taxation. Spouses who make gifts to each other are exempt from paying taxes on those gifts. Non-U.S. citizens who reside in the United States but make a gift of property located outside of the United States are not subject to the gift tax. Gifts to political organizations are also exempt. Finally, any payments made to educational institutions or medical care providers on behalf of someone else are completely exempt from taxation. This exception allows parents who pay college or graduate school tuition for their children to avoid having to pay the gift tax. Note that to take advantage of this exemption, however, the payments must be made directly from the donor to the educational institution or medical care provider.
The gift tax must be paid either in the year in which the gift was made or the year in which the transfer of ownership is considered complete. Under federal law, a gift is made when the owner transfers property to another without receiving payment of any kind and without the possibility of getting it back, such that the owner no longer has any control over the gifted property. Once the owner of gifted property loses the power to amend, alter, or revoke the gift, the transfer is considered complete. For example, if the owner of an apartment complex transfers management and the rights to rental income to his daughter in year one, but does not amend the deed to the property until year two, the gift is considered to occur in year two, when the owner has released all claims to the property by amending the deed.
Typically, gift recipients are not liable to pay taxes, but a decision to later sell the property they received as a gift will result in important consequences regarding taxable gains. The most important rule here is that, under federal tax law, the recipient takes the donor’s tax “basis” in the property. The concept of basis is best explained by illustration. Going back to our example, assume the daughter who received the apartment complex as a gift from her father decides to sell the property. The father originally purchased the apartment complex for $500,000 (his “basis”), the fair market value at the time the gift was completed was $700,000, and the daughter sold the property for $1 million. When the daughter goes to sell the property, her basis will also be $500,000 – the same as the father’s – and not the fair market value at the time she received the apartment complex as a gift. The daughter would then be taxed on her gain of $500,000 (the difference between the sale price of $1 million and her basis of $500,000). The logic behind this rule is that family members should not be able to reduce their taxable gains on a property by shifting it to someone else in the family just before selling.
Lastly, taxation of gifts can become complicated for the donor at the time of death. The gift tax is tied to the estate tax and is structured so that taxpayers cannot avoid the estate tax by gifting away their property prior to their death. Under current law, after an individual passes, the estate can give away up to $5 million tax-free. However, the amount of any gifts made during the donor’s life will count against this $5 million limit. Of course, most individuals and estates will not incur the estate tax, as the value of their estates will be well below $5 million. Nevertheless, the federal gift tax can be a complicated area of tax law, so seeking the expert and personalized advice of an experienced tax attorney can be a great help.