By Alfred C. Greenfield, Jr.
You come home from work and get the mail like you do every day, but today is not like every other day. Today, there is an envelope from your parents and inside is a check with a note saying how they wanted you to have this. The first thing that pops into your head is this could not have come at a better time with your oldest child getting ready to start college in a month.
The second thing that enters your mind is to wonder if you have to claim this on your taxes. The answer to that is no, but your parents may depending on many different factors behind the gift.
The scenario above is more common than one may think, and more often than not people are unsure how to handle it from a tax perspective. It is called a gift, and while many of us are probably familiar with the term “gift tax,” we are not sure exactly what it is and how it works.
The first thing to do is define the term “gift.” According to the IRS, a gift is: "Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.” For example, if you hand someone a check for $8,000, that’s a gift. And if your car could be sold for $15,000 on the open market, but you sell it to your daughter for $5,000, you’ve made a $10,000 gift to her.
Now we have to determine if the gift is taxable or not. If the gift is less than $14,000 in 2015 (the threshold is subject to change each year based on new tax laws), then it is not taxable to the donor as it is less than the annual exemption. However, remember with the gift tax that it is the person making the gift that has to pay any required gift tax, not the recipient of the gift. So for the two examples above, neither would be taxable as they are less than the annual exemption.
So then does that mean that if we give a gift to someone that is larger than the annual exemption that it must be taxable? The answer is not necessarily. There are some exceptions to the tax laws—as there are with every tax law—and they are as follows:
According to the IRS website, the general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.
- Gifts that are not more than the annual exclusion for the calendar year.
- Tuition or medical expenses you pay for someone (the educational and medical exclusions).
- Gifts to your spouse.
- Gifts to a political organization for its use.
- In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.
In addition to the rules above there are some additional factors to consider. First, there is a lifetime gift amount exemption of $5,340,000 after which ALL gifts are subject to the gift tax unless they are to your spouse as there is no limit on those gifts. In addition, if you are married, then the annual exemption doubles to $28,000 per recipient even if the gift comes entirely from one of the married people. The best way to help add some clarity to this muddled tax situation is examples, so let’s review these so you can use them as guidance in your potential situation.
Mary is a single
- The first is to give each child $14,000 each for a total of $56,000 and hold on to the remaining $4,000 until next year where she can give them each $1,000. Doing so would result in zero gift tax.
- For the second choice, she can give them all $15,000 each this year and have $4,000 (($15,000–$14,000)*4 children) be subject to the gift tax at a rate of 22% for a total of $880 in gift tax.
2. Mike is married and wants to give $40,000 to each of his two children to cover the cost of their kids’ college tuition. He has three choices here, and the third one is the best option:
- The first is to give $28,000 to each child this year and the remaining $12,000 next year (remember that as he is married, the exemption doubles) so that no gift tax would be required.
- The second is to give them all $40,000 for a total of $80,000 and have $24,000 subject to the gift tax, which would be ($40,000 - $28,000)*2 children, at a rate of 30% for a total of $7,200 in gift tax.
- The third choice is to send the $40,000 check directly to the educational institutions in the grandchildren’s name for their tuition, and none of it is subject to the gift tax because it meets one of the four exemptions listed above.
3. Joe is married and wants to sell his summer home to his son Jeff for $20,000. The house is appraised at a value of $150,000 and has no mortgage. This will result in a gift of $130,000. However, that does not mean that all of it is taxable as Jeff is also married. Since Joe is married and so is Jeff, the total exemption is $56,000 as Joe can give both Jeff and his wife $14,000 each and so can Joe’s wife ($14,000 * 4 = $56,000 total exemption). However, the remaining 74,000 is subject to the gift tax and is taxed at the 34% rate for a total gift tax of $25,160.
- On a side note for this example, Joe could sell the home and pay the capital gains rate on it (as it has not been his primary home seeing as it is a summer home) and then give $56,000 a year, each year, until the full $130,000 is given over, which would work if he sold the home to Jeff for the full $150,000 and used the proceeds as his gift, which Joe could then use to pay off the mortgage early.
As you can see, this situation can, and often does, reach more than just the wealthy and it is good to have at least a working knowledge of how the gift tax works. If you are ever in doubt, check with a tax professional as it is better to be safe than sorry.
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Alfred C. Greenfield, Jr.,
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