What Gifts Are Subject to the Gift Tax?
Exemptions, exclusions, and exceptions can help you avoid the tax
The federal gift tax is payable by the donor, not the recipient of a gift, and it doesn't apply to all gifts made during the donor's lifetime. Individuals are free to give money or property away in relatively small increments. You can even give certain gifts of more significant value because they're exceptions to the usual rules.
The idea behind the gift tax is to prevent taxpayers from giving away their assets tax-free during their lifetimes to avoid their estates from being subject to the estate tax when they die.
What Counts As a Gift?
Whether a gift is taxable depends on three factors:
- Who received it
- Its fair market value
- Whether it was a present interest gift or a future interest gift
The Recipient of the Gift
All gifts made to your spouse are exempt from the federal gift tax provided that your spouse is a U.S. citizen. The federal unlimited marital deduction allows spouses to give property to each other without taxation either before or after death.
You can give up to $157,000 a year to a spouse who isn't a U.S. citizen as of 2020. This threshold usually increases periodically because it's adjusted for inflation.
Gifts to political organizations and qualifying charities are fully exempt as well, although certain rules do apply. For example, gifts made to political organizations must be for their own use.
You can pay someone's medical bills with no limit and without incurring a gift tax if you make the payments directly to the care provider. Educational gifts in the way of tuition are exempt as well, but you must pay the educational institution directly in this case, too. It's considered a gift if you pay someone's credit card bill for them, even if it's to cover medical or education expenses.
Fair Market Value
A gift is anything you give without receiving fair market value in return. The IRS defines fair market value as what would be paid for an item or asset if neither the buyer nor the seller was under any duress to complete the transaction. In other words, it's not a fire sale.
There's no dispute as to value if you give cash. You've made a $10,000 gift if you give someone $10,000 and receive nothing in return. But you're considered to have given a gift of $150,000 if you sell someone a $300,000 home for $150,000, because you didn't receive anything in exchange for half the property's value.
Fair market value is typically a gift's appraised value or a value comparable to other similar items sold at the same point in time and in the same condition.
Gifts of Present vs. Future Interest
A gift of present interest is one that the recipient is free to use, enjoy, and benefit from immediately—no strings attached. It's a future-interest gift if the recipient doesn't have complete use and enjoyment of it until some future point in time, and this is an important distinction.
Common examples of future interest gifts are reserving a life estate in real estate or funding a trust. In either case, your beneficiary typically doesn't become the full and vested owner until your death.
The Timing of Gifts
At least some portion of a $25,000 check you give to one individual would be taxable in the year you actually write and hand over the check. The tax would be incurred for the 2020 tax year if you give the check in December, even if the recipient doesn't cash it until 2021.
Loans and Cancelled Debts
That same $25,000 check is still taxable to some extent if it's a loan but you don't charge the applicable federal interest rate. The actual "gift" is the difference between the rate you did charge—if any—versus the federal rate in place at that time.
This rule only applies to loans of more than $10,000, however...unless you "forgive" the debt, declining repayment. In this case, the whole check becomes taxable, or at least the portion that doesn't qualify for any exemptions or exclusions.
The Annual Gift Tax Exclusion
Federal law exempts the first $15,000 you give per person per year in both 2020 and 2021. This annual exclusion from the gift tax can increase periodically in $1,000 increments to keep pace with inflation, but it doesn't always do so. You can apply it to gifts made to anyone other than your spouse, such as your children. Only the balance of the gift's value over $15,000 is taxable.
For example, $15,000 of the gift would be free and clear of the federal gift tax under the annual exclusion if you make a one-time gift of $115,000 to your child for the purchase of a home, but the remaining $100,000 is considered would be a taxable gift.
The first $15,000 would be free and clear of the federal gift tax and only $85,000 would be a taxable gift if you give your son $15,000 in December and an additional $100,000 in January of the following year. This is an annual exclusion—$15,000 per person per year—and $100,000 less the $15,000 for the subsequent year works out to just $85,000.
You could also give both your child and their spouse $15,000 each in this scenario, effectively doubling your exemption.
Spouses can effectively team up and give twice the annual exclusion amount to a single beneficiary in the same tax year: $15,000 from one spouse and $15,000 from the other as of 2021.
The Lifetime Exemption
Federal tax law also offers a lifetime exemption from the gift tax, but it's shared with the estate tax. This lifetime exclusion is sometimes referred to as the Unified Tax Credit because it covers both taxes. It's a very significant $11.7 million as of tax year 2021.
You can either pay the gift tax on the balance of a gift over the $15,000 annual exclusion, or you can apply the balance to this lifetime credit. No gift tax would be due, but the amount of a gift is subtracted from exemption each time you do this, leaving less to shelter your estate from taxation at the time of your death. Only very sizable estates should be affected by this rule, however.
NOTE: Tax laws change periodically so you should always consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and is not a substitute for tax advice.
IRS. "Frequently Asked Questions on Gift Taxes for Nonresidents not Citizens of the United States." Accessed Nov. 16, 2020.
IRS. "Frequently Asked Questions on Gift Taxes." Accessed Nov. 16, 2020.
IRS. "Publication 559 Survivors, Executors, and Administrators." Page 26. Accessed Nov. 16, 2020.
Legal Information Institute. "26 U.S. Code § 7872 - Treatment of Loans With Below-Market Interest Rates." Accessed Nov. 17, 2020.
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2021." Accessed Nov. 16, 2020.