Learn About Gift Taxes and What You'll Have to Pay
The gift tax doesn't cost everyone cash out of pocket
The U.S. federal gift tax is probably the most misunderstood tax in the country. It seems incredible that you can't just give away your property away without incurring any tax consequences.
Fortunately, the tax code isn't quite that unforgiving. It includes two "exclusions" or "exemptions" that taxpayers can use on either an annual basis or to spread out their gifts over their entire lifetime.
The Annual Gift Tax Exclusion
The annual gift tax exclusion is the amount you can give away per person per year tax-free, and it covers an unlimited number of people. Gifts given once a year or even a series of gifts made to the same person during the course of one calendar year aren't subject to the gift tax if they don't exceed the annual gift tax exclusion: $15,000 in 2018, up from $14,000 in 2017.
Here's how it works. You can give your daughter $5,000 in January 2018, another 5,000 in June, and another $5,000 in December and no gift tax would come due. You've reached the $15,000 limit but you haven't exceeded it.
You can even give her another $5,000 in January 2019 without incurring a gift tax—yet—because this would count against the 2019 annual exclusion. This gift would only be taxed if you exceeded 2019's exclusion.
You can also give your son a car worth $15,000 in 2018. You can give each of your grandchildren stocks worth $15,000 each, and your best friend a diamond ring worth $15,000. Again, each and every "gift" will not be considered a gift at all for federal tax purposes because you've given no more than $15,000 to each individual.
The Lifetime Gift Tax Exemption
The lifetime gift tax exemption is the total amount you can give away over the course of your entire lifetime. These gifts will be free from taxation as well.
But the overall gifted amount will reduce the amount of exemption you have left to shield your estate from U.S. federal estate taxes at the time of your death. If you gift away any amount of your lifetime gift tax exemption, this amount is subtracted from your estate tax exemption when you die because both taxes share the same exemption.
Under the provisions of the American Taxpayer Act of 2013 (ATRA), the lifetime gift tax/estate tax exemption is indexed for inflation so it increases by year. It was $5.45 million in 2016 and $5.49 million in 2017. Then the Tax Cuts and Jobs Act (TCJA) hiked it up to $11.18 million beginning in 2018.
Yes, you read that correctly. The TCJA more than doubled the lifetime exemption, but only temporarily. The TCJA expires at the end of 2025 unless Congress acts to renew its provisions.
So, if you give away $10 million during your lifetime and you die in 2018, your federal estate tax exemption will only be $1.18 million—the balance of the exemption after all your generous gifting. If your estate is worth more than $1.18 million, it will owe an estate tax on its value over that amount.
What Happens When You Make a Taxable Gift
What happens if you make a total of $120,000 in gifts to your daughter in one year? Then you will have made a taxable gift to your daughter equal to $105,000 in 2018—$120,000 less the $15,000 annual exclusion.
That $105,000 will reduce your 2018 lifetime exemption from $11.18 million to $11,179,895.
Taxable gifts must be reported to the IRS on Form 709, the United States Gift (and Generation-Skipping Transfer) tax return. The return is due on the same date as your personal income tax return, April 15 of the year after the year in which the taxable gifts were made. This is how the IRS keeps track of how much of your lifetime exemption you've used up.
Special Gift Tax Rules
Some types of gifts that aren't considered gifts at all. They really are "freebies". Special rules apply to gifts made by a U.S. citizen to a spouse who is not a U.S. citizen, and the unlimited marital deduction applies to gifts made by a U.S. citizen to a spouse who is also a U.S. citizen.
The Bottom Line on Taxable Gift
Consult with an accountant or an estate planning attorney if you're about to make a significant taxable gift. You won't want to be surprised by the gift tax consequences after the fact. At least through 2025, however, you have $11.18 million in wiggle room.