Who Must File and Pay the Federal Gift Tax?
All individuals who make a gift to another individual or entity that exceeds a certain amount must file a federal gift tax return and pay the federal gift tax. The donor--the gift giver-- is responsible for paying the gift tax, except in certain circumstances in which the IRS allows the gift recipient to pay the gift tax.
The gift giver must report the gift by completing IRS Form 709 and attaching payment by the same day as the income tax returns (April 15). (If you extend your federal tax return filing deadline to October 15, the extended deadline also applies to Form 709). Alternatively, the gift giver can elect not to pay the tax at the time of filing the return and instead opt to use some of the unified gift and estate tax exemption to defer payment. You must fill out Form 709 each year that any additional gifts go over the gift tax exemption amount.
Only one state--Connecticut -- imposes a gift tax at the state level in addition to the federal gift tax.
What are Taxable Gifts?
Nearly all property, tangible or intangible, can be considered a gift subject to the gift tax. Stocks, jewelry, real estate, cars, art, and cash are examples of things that can be gifted as well as interest-free or below market interest loans made to another person and services.
How is the Gift Tax Calculated?
The gift tax is calculated based on the fair market value of the property at the time of transfer. Fair market value is the price agreed to for an asset by a willing buyer and seller.
However, gifts below a certain threshold amount are exempt from taxation. This means that each calendar year you give below the annual gift tax exclusion, you do not have to pay the gift tax. For gifts made in 2019, the exclusion amount is $15,000, the same as in 2018, but up $1,000 from the 2017 amount of $14,000. In 2019, married couples can make combined gifts of up to $30,000 without being subject to the gift tax. For gifts over $15,000 per person per year, the gift giver must file a gift tax return.
Gift Tax Exemptions for Certain Types of Gifts
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 gift giver to the educational institution or health care provider.
Timing of Gift Giving
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.
Tax Consequences of Selling Gifted Property
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.
Calculation at Death
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 $11.4 million tax-free (adjusted for inflation). However, the amount of any gifts in excess of the annual gift tax exemption that are made during the gift giver's life is tallied up and counted against this $11.4 million limit. Of course, most individuals and estates will not incur the estate tax, as the value of their estates will be well below $11.4 million. (The 2017 Tax Cuts and Jobs Act doubled the lifetime annual exclusion starting 2018, without taking into account the necessary inflation adjustment; however, the 2017 Act also provides that the exclusion amount would return to 2017 levels in 2026.)
For example: say you gave your favorite cousin $25,000 in 2019 as a gift. The 2019 annual exemption is $15,000. You are $10,000 over the limit. You must file Form 709 to report the gift, but you will not have to worry about paying the gift tax since the $10,000 will be subtracted off your lifetime gift tax exemption ($11.4 million). Should you die in 2019 and had made taxable gifts of $2 million in prior years, the unused exclusion would be $9.39 million ($11.4 million less $2 million less $10,000) rather than $11.4 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.