It’s Giving Season: Gift Tax Basics
November 28, 2016 : Eli Colmenero – The Tax Institute
‘Tis the season for sweet holiday treats, candy cane lattes and long retail store lines. Because you are probably already worrying about getting the perfect gift for important people in your life, we will let you know up front; you shouldn’t worry too much about taxes during the gift giving season.
Why? Because most gifts can be given completely tax free. Even better, the impressive check grandma cuts every Christmas is only taxable to her if her gift exceeds certain thresholds. So don’t worry about paying taxes on gifts you receive, but read on to see if grandma should file a gift tax return this coming April.
What is Gift Tax?
People transfer money and other items to friends and family members all the time – and for various reasons, whether it’s a gift or just to help each other out. The consequences for these transfers are often an afterthought, so it’s important to understand the basics rules about gift tax.
What is a Gift — In Taxation Terms?
A gift occurs when a taxpayer transfers property for less than full and adequate consideration. The transfer must be complete and irrevocable. A transfer is a gift only if the donor cannot take the property back and the donee receives full enjoyment to do what she pleases with the property – it’s an objective determination, meaning the subjective donative intent is not required for the gift tax to apply.
In some instances, tax code will treat loan transactions as gifts.
A below-market interest rate loan between family members is a gift loan. The gift is the excess of the amount loaned over the present value of all required payments under the loan. If the lender does not require payment by a particular date, the gift is instead the amount of interest the lender would charge if the applicable federal interest rate were used to calculate interest. However, the IRS does allow an exception for de minimis below-market rate loans of $10,000 or less.
A taxpayer adds a person to the title of real estate or bank account. State-level property laws dictate whether creation of a joint tenancy with rights of survivorship create a gift. However, generally speaking, if a parent adds a child as a joint tenant to real property, the tax code considers the parent making a gift of half the fair market value of the home if either joint tenant has a legal right to sever his interest. An important exception to this rule exists for marital transfers—there is an unlimited marital deduction for gifts between spouses.
When determining your taxable gifts, you must subtract $14,000 of gifts made to any one person during the calendar year. This is known as the annual exclusion. In fact, consenting spouses can make a special election to split all gifts made during a calendar year which will treat each gift as made half by each spouse—functionally creating a $28,000 annual gift exclusion for consenting spouses.
Maude has five children and gifts $14,000 to each child. Maude can make this gift once per year, a total of $70,000 annually, without any gift taxes imposed. If Maude made these gifts for ten years, she would transfer $700,000 to her children entirely tax-free. In this circumstance, Maude will not even have to file a Form 709 “gift tax return” her gifts do not exceed $14,000 per year.
If Maude elected to split gifts with her spouse, she would then be able to give $28,000 per year to each child. Thus, she would gift $140,000 per year to her children or $1.4 million over a decade completely free of gift tax. However, Maude will need to file Form 709 to elect gift splitting with her husband.
A unique aspect of our tax code is that the gift and estate tax schemes are unified. Meaning that a taxpayer’s gift and estate taxes are computed based on the cumulative transfers made by a taxpayer using one tax rate and one exclusion amount—this unified credit is sometimes called “the lifetime exclusion”.
A taxpayer may charge taxable gifts against the lifetime exclusion, and the taxpayer’s estate may then use any remaining amount. For the tax year 2016, the lifetime exclusion amount is $5.45 million with a $2,125,800 credit against imposed gift tax. Essentially, taxpayers are handed a free pass on gift tax up to $2,125,800 so long as the aggregate amount of taxable gifts during the donor’s lifetime does not exceed the lifetime exclusion.
Gift Tax Reporting Requirements
A taxpayer must use Form 709 to report gifts to the IRS to report a gift. In most instances, you will file Form 709 when gifts made to one individual are more than $14,000. If a donor transfers property and the donee may only use or enjoy it upon the happening of a later event—called a future interest—the donor must report the present value of the gift because future interests are not subject to the $14,000 annual exclusion.
If a taxpayer living in a community property state gifts community property, the gift is treated as half from the taxpayer and half from the taxpayer’s spouse. Because spouses may not file joint gift tax returns, each spouse would then report half the value of the community property on their respective Forms 709. The same reporting rule applies to spouses in non-community property states who own property as joint tenants or tenants by the entirety.
The filing deadline for Form 709 is April 15 of the year after the gift is completed. If an extension is needed, an automatic Form 709 extension will result from an extension of time granted for filing the federal income tax return Form 1040. If a taxpayer does not request an extension for their income tax return, Form 8892 is filed by the regular Form 709 due date for an automatic six-month extension.