Overview of the Federal Gift Tax
The Gift Tax is a federal tax that is imposed on any transfer made during the life of the transferor that is made without consideration. “Consideration” in this context means something of value in return for the transfer. In some cases, the Gift Tax is applied to a portion of a transfer that is given in exchange for consideration that is below the value of the transfer. For example, if your parents decide to give you $30,000 for mowing the lawn, and mowing the lawn has a fair market value of $50, the remaining $29,950 may be subject to the tax.
However there are exemptions that apply to the federal Gift Tax law as well.
The Lifetime Gift Exemption
If you “gift” over the personal exemption amount allowed per year, the excess amount will be applied to your Lifetime Gift Tax Exemption.
The 2017 Tax Cuts and Jobs Act doubled the exemption from $5 million to $10 million, but without adjusting those figures for the annual cost of living increase. For 2019, the inflation adjusted exclusion amount is $11.4 million for individuals (up from $11.18 million in 2018), double for joint filing married couples. (Under the 2017 Tax Act, the boost in the exclusion amount expires December 31, 2025 at which time the amount returns to the 2017 levels -- $5.49 million for individuals and $10.98 million for married couples). This means that even if you gift over $15,000 a year singly, or $30,000 jointly with your spouse, and you have not exhausted your lifetime exemption amount, you will just reduce your lifetime gift exemption by the amount that exceeds the annual exclusion (see below). If you exceed the limit, you (or your estate) could end up owing tax of up to 40%.
Annual Gift Tax Exemption
The annual gift tax exemption is $15,000 which can be made to one or more individuals as you like or in a lump sum to one individual (the amount increases every so often to adjust for inflation). So, for example, your father can give a total of $15,000 to you in 2019, without any gift tax liability. This means all gifts-- graduation, anniversary, wedding, showers, birthday, holidays, or "just because". If the total gifts exceed $15,000, then the amount over $15,000 is a taxable gift.
Let's say, in 2019, your dad is very generous to you and gives you a total of $45,000 in gifts. This results in a $30,000 taxable gift to you ($45,000-15,000). The taxable gift first reduces his lifetime gift tax exemption (currently $11.4 million) against gift and estate taxes. Only once the exemption is fully used up does your father pay the federal gift tax (or his estate pays the estate tax). So the more of that exemption your dad can avoid using during his lifetime, the more credit his estate will have to use to pay the estate tax.
Spouses can combine their exemption when gifting their property. Gifts in excess of the annual exclusion do count against the lifetime exemption.
Filing a Gift Tax Form with the IRS
Anytime you make a gift over the amount of your annual personal gift exemption, you need to file a form 709 with the IRS. This does not mean that you will necessarily have to pay a tax on this excess amount, however, the IRS will keep the 709 on its records and apply any excess gift amount to your Lifetime Gift Exemption. Further, filing a 709 form with the IRS will give them a maximum of three years to make an inquiry on any property you have gifted.
If you do not file a 709, the IRS can come back four or more years later and determine that the value of the gift exceeded the amount that you assessed it at. This may mean that you will be faced with an unexpected tax if this extra amount puts you over your Lifetime Gift Exemption limit. For example, let’s say that the Lifetime Gift Exemption is set at $1,000,000, at a 55% excess tax rate, and you already have racked up $600,000 on your Lifetime Gift Exemption amount. You then decide that your last gift will be a vacation house to your children, which you believe is valued at $413,000. You believe that after your personal pre-2013 yearly exemption of $13,000, the excess amount of $400,000 will fall neatly into your Lifetime Gift Exemption, and you and your children will be able to make the transfer tax-free. Now let us suppose that four years later, the IRS makes an inquiry on this gift. After the inquiry, the IRS decides that the house was worth $613,000 instead of $413,000. If you filed a form 709, the IRS will be precluded from taxing you on the excess $200,000 since more than three years have passed. However, if you failed to file a form 709 with the IRS, at a tax rate of 55%, you will be responsible for paying over $100,000 in taxes for this gift.
Gift Tax and Estate Planning
Giving gifts of property during your lifetime is a great way to make tax-free transfers to your heirs, as long as you do not exceed your Lifetime Gift Exemption. If you want to determine the best way to gift your property, or have other tax-related estate planning questions, you should contact a tax attorney or estate planning attorney in your area.