How Does the IRS Track Gifts for the Gift Tax?

Individual taxpayers give gifts all the time – birthday presents, graduation gifts and holiday gifts are commonplace. Many people don't realize that there are limits on how much you can give away during the year before taxes must be paid, and more people still don't realize that it's not the recipient who owes the tax, but the giver.

Regardless, the gift tax only applies to gifts worth over a certain dollar amount, and there are other exclusions that prevent most people from ever having to pay a gift tax during their lifetimes. If you are generous enough to give above and beyond the IRS limit, the gifts are self-reporting, and the IRS relies on you to be honest about your giving.

Gift taxes are only assessed on gifts given above a certain dollar amount (the "exclusion" amount), per recipient, per year, that total more than the exemption amount. If you give one person more than the exemption amount during the tax year, you must report the gift to the IRS on the IRS Form 709. You are required by law to report the gift, and if you don't, it could come out in an audit. This is how the IRS determines whether you owe gift tax.

The amount you can gift to one person during one tax year is called your exclusion amount. You can give any one person money up to the exclusion amount, and you will not have to report it. If you give one person more than the exclusion amount during the tax year, you must complete the Form 709 and report it to the IRS, but you will not be taxed at that time.

Throughout your life, you can continue to gift up to the exclusion amount every year, and you must report the amount you go over the exclusion every year. The amount you go over will be added up over your lifetime, and if the amount over your lifetime exceeds the lifetime exemption amount, you will be taxed on the excess.

Read More: How to Calculate an IRS Gift Tax

You do not have to report all gifts on Form 709. Certain types of gifts are not IRS gift money. You can pay someone else's medical bills or tuition bills without the funds counting toward the exclusion and exemption amounts. You can also make donations to an exempt organization, and these gifts will not be included. In fact, these are not considered "gifts" for tax purposes at all.

This applies to medical bills and tuition only if you pay them directly rather than giving the money to the individual; if you do that, it's a gift and must be reported above the exclusion amount.

If you want to contribute to a 529 college savings plan, it is considered a gift for gift tax purposes; however, you're allowed to contribute up front up to five years of excluded gift tax as an initial contribution, and it will be treated as though you've contributed the exclusion amount every year.

For the 2020 tax year through the 2025 tax year, the exclusion amount is $15,000. This means you can give up to $15,000 per year to one person without having to report the gift to the IRS. The lifetime exemption amount for these tax years is a whopping $11.58 million, up from $11.4 million in 2019, so even if you give more than $15,000 per year to one person, that cumulative overage would have to exceed $11.58 million before a tax is assessed.

For example, if you give your niece $20,000 every year from 2020 through 2024, you will be exceeding the exclusion amount by $5,000 per year. You will have to report that $5,000 every year on the Form 709, and over five years, you will have reported $25,000 in excess gifts. If you die in 2024, you will not be taxed on that $25,000, because that amount is less than $11.58 million.

However, if you're very wealthy, and you give your niece $3 million every year from 2020 to 2024, you will have gifted her $15 million over five years. Every year, you would need to report $2.985 million on Form 209, which over five years equals $14.925 million.

If you die in 2024, your gifts to her will have exceeded the limit, and you will be taxed on the difference ($14.925 million minus $11.58 million), which is $3.345 million. The tax rate for gifts is 40 percent, so the tax on that amount that will be assessed to your estate is $1.498 million.

Read More: The Federal Gift Tax and Holiday Giving