What Gifts Are Subject to the Gift Tax?
Exemptions, exclusions, and exceptions can help you avoid the tax
The federal gift tax is often misunderstood. You don't have to pay it if a generous soul gives you something particularly valuable. The generous soul gets dinged by the IRS. The tax is payable by the donor, not the recipient of the gift.
And it doesn't apply to all gifts made during the donor's lifetime. Individuals are free to give away money or property in relatively small increments as long as those increments don't add up to a mountain of generosity. You can even give certain gifts of more significant value because they're exceptions to the usual rules.
Whether a gift is taxable comes down to three factors: who received it, its fair market value, and whether it was a present interest gift or a future interest gift.
The idea behind the gift tax is to prevent taxpayers from giving away all their assets before death in an effort to avoid an estate tax when they die. But it can still be possible to avoid at least estate tax by working these gift tax rules to your advantage.
What Counts as a Gift?
A gift is anything you give away without receiving fair market value in return, assuming that it doesn't qualify for an exclusion from the tax, but this isn't quite as black-and-white as it might seem on the surface.
At least some portion of a $25,000 check given to one individual would be subject to the tax in the year you actually write and hand over the check. For example, the tax is due for the 2019 tax year if you give the check in December, even if the recipient doesn't cash it until 2020.
That same check is still taxable to some extent if it's actually 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 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.
Gifts of Present Interest vs. Gifts of 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. This is an important distinction.
Future interest gifts don't qualify for any of the gift tax exclusions and exemptions. The entire gift is taxable and must be reported to the IRS on Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return.
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 Recipient of the Gift
All gifts made to your spouse are exempt from the federal gift tax as long as 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.
As of 2019, you can give up to $155,000 a year to a spouse who isn't a U.S. citizen. This exemption is adjusted for inflation and increases a little each year.
Gifts to political organizations and qualifying charities are fully exempt as well, although certain rules apply. Gifts made to political organizations must be for their own use.
You can pay someone's medical bills with no limit as long as you make the payments directly to the care provider. Educational gifts in the way of tuition are also exempt, but again, you must pay the educational institution directly.
But if you pay someone's credit card bill for them, even if it's to cover medical or education expenses, that's a gift.
What's Fair Market Value?
The Internal Revenue Service defines fair market value as what one individual might pay for an item of property if neither the buyer nor the seller were under duress to complete the transaction—in other words, it's not a fire sale.
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.
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.
The Annual Gift Tax Exclusion
Federal law exempts the first $15,000 you give per person per year as of 2019. This annual exclusion from the gift tax increases periodically in $1,000 increments to keep pace with inflation. You can apply it to gifts made to anyone other than your spouse, such as your children.
If you make a one-time gift of $115,000 to your son for the purchase of a home, $15,000 of the gift is free and clear of the federal gift tax under the annual exclusion, but the remaining $100,000 is considered a taxable gift.
But the first $15,000 is free and clear of the federal gift tax and only $85,000 is a taxable gift if you give your son $15,000 in December and an additional $100,000 in January of the following year. Remember, this is an annual exclusion. $100,000 less the $15,000 for the subsequent year works out to just $85,000.
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 2019, making the total gift $30,000, but still not taxable because it's covered by two separate exclusions.
Then There's 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 called the Unified Tax Credit. It's a very significant $11.4 million as of 2019.
You can either pay the gift tax on the balance of a gift over the annual exclusion amount, or you can apply the balance to this lifetime credit. No gift tax would be due, but there's a downside—at least for wealthier individuals.
The amount of the gift applied to the lifetime exemption is subtracted from it each time you do this, leaving less of the exemption 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.