Although the federal government imposes a gift tax, it's not as if the Internal Revenue Service maintains a massive database of every gift given in the country. It relies on people who give taxable gifts to report them using gift tax returns. The IRS says that "any gift is a taxable gift," but significant exceptions exist.
Gift Tax Basics
Under the IRS definition, a gift is anything you give to another person — cash or property — without getting value in return. When the gift tax applies, it is the responsibility of the person giving the gift to pay it, not the recipient. Someone who gives a taxable gift must report it to the IRS using a gift tax return, Form 709. This form also is used to calculate and pay the tax due. As of 2015, the tax rate ranged from 18 percent to 40 percent.
Several important exceptions prevent most gifts from being taxed. The first of these is the "annual exclusion," which as of 2015 was $14,000. That means you can give someone up to $14,000 worth of gifts in a year without having to pay tax. The tax would kick in once the total amount given to that person exceeded that amount and it would apply only to gifts beyond the $14,000 limit. The exclusion applies on a person-to-person basis. You have a separate $14,000 exclusion for each person you give gifts to.
Gifts to a spouse are completely free from tax, as long as that spouse is a U.S. citizen. If your spouse is not an American citizen, the amount you can give without paying tax is limited by law. As of 2015, the first $147,000 worth of gifts to a noncitizen spouse was untaxed. Exclusions also apply to certain gifts for medical or educational expenses. If you pay someone's medical bills or tuition bills, the money is not subject to gift tax as long as you pay it directly to the health care provider or the school. If you give the money to the person, it's a gift and may be taxable. Gifts to political organizations also are untaxed.
Link to Estate Tax
One of the primary purposes of the gift tax is to prevent wealthy people from evading estate taxes after they die by simply giving away all their assets while they're alive. As a result, the gift tax is closely tied to the estate tax. And just as the gift tax doesn't apply to most gifts, the estate tax doesn't apply to most estates. As of 2015, the first $5.43 million worth of assets in any estate is exempt from tax. However, the law allows people to essentially "use up" that exemption while they're still alive in order to avoid paying gift tax. Say you give someone enough money or property that you are on the hook for $100,000 worth of taxable gifts. Instead of paying the gift tax, you have the option of using up $100,000 worth of your estate tax exemption. Your estate tax exemption would then drop to $5.33 million.
Penalties for Evasion
Knowingly failing to report a taxable gift is tax evasion. Someone caught evading taxes will not only have to pay what they owe with interest, but also can be hit with a civil fraud penalty equal to 75 percent of the tax due. Criminal penalties can range up to $250,000 in fines and five years in prison.
- IRS.gov: Frequently Asked Questions on Gift Taxes
- IRS.gov: Instructions for Form 709
- IRS.gov: Avoiding Penalties and the Tax Gap
- IRS.gov: Related Statutes and Penalties -- General Fraud
- Internal Revenue Service. "Frequently Asked Questions on Gift Taxes." Accessed Oct. 16, 2020.
- Internal Revenue Service. "2020 Instructions for Form 709," Page 19. Accessed Oct. 16, 2020.
- Internal Revenue Service. "What's New – Estate and Gift Tax." Accessed Oct. 16, 2020.
- Internal Revenue Service. "2020 Instructions for Form 709," Page 7. Accessed Oct. 16, 2020.
- Internal Revenue Service. "2020 Instructions for Form 709," Page 8. Accessed Oct. 16, 2020.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.