Uncle Sam isn't a big fan of generosity, and this is logical if you think about it. A portion of the nation’s revenue comes from estate taxes, and this source would dry up if everyone were to give all their property away tax-free during their lifetimes to avoid having their loved ones pay an estate tax on the value of their estates when they die. So the IRS imposed a federal gift tax to cover lifetime gifts, too, beginning in 1924.
Unfortunately, nowhere does the IRS say, “Aw, never mind. It’s a holiday.” It doesn’t matter when or why you give. The federal government will still want its share of the value of some of those gifts.
When Is a Gift Considered a Gift for Tax Purposes?
According to the IRS, a gift is “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.” So if you give your son that awesome new car he’s been wanting, it’s a gift for tax purposes unless he pays you for it.
And don’t skim over that term “full consideration.” Your son can’t give you $5 for a $35,000 car. You must receive fair market value for the vehicle, which the IRS defines as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
It’s Better to Receive
Recipients aren’t responsible for paying the gift tax, although an exception exists for gifts from foreign sources. Donors have to pay the tax, but tax law provides several ways for them to get around it. The IRS isn't totally without a heart, and the Internal Revenue Code includes several rules and exclusions for dodging the gift tax.
The 2019 Gift Tax Exclusion
First, you can give property or cash up to $15,000 per person per year in the 2019 holiday season. This exclusion is indexed for inflation, so it might increase in future years.
This means you can give your son $15,000 toward that car and your daughter $15,000 toward her own dream gift and the IRS will say, “OK, no harm, no foul, no gift tax.” And because this is an annual exclusion, you could give your son $15,000 on Dec. 31 and $20,000 on Jan. 1. You’d only owe a gift tax on the $5,000 balance of the cost of the car – the difference between the $15,000 gift tax limit in January and the $20,000 you gave him.
Read More: Claiming Education Expenses on Taxes
Then There's Gift-Splitting
Wait, it gets better. You and your spouse each get a $15,000 annual exclusion, for a total of $30,000. So you could give your son $15,000 in December, $15,000 in January, and your spouse could pick up that extra $5,000 under her annual exclusion. Voila – no gift tax.
This marital tactic is referred to as “gift splitting” even though you’re not actually splitting anything but rather doubling the exclusion amount. You do have to file a gift tax return – IRS Form 709 – to let the IRS know that this is what you’re doing, but no tax will be due.
The Lifetime Unified Tax Credit
You have still more wiggle room because the IRS also provides a lifetime exemption, and this one is a whopper: $11.4 million as of 2019. And yes, each spouse also gets their own $11.4 million exemption for a total of $22.8 million. The Tax Cuts and Jobs Act effectively doubled this exemption when the law went into effect in 2018.
Here’s how it works: You want to give your son that $35,000 car, and you want him to wake up to it on Christmas morning. You don’t want to wait to buy it for him on Jan. 1 when you’re eligible for another $15,000 annual exclusion, and you’re not married so you can forget about gift-splitting.
Not a problem. Give him the car and use your $15,000 annual exclusion for the current year, then charge the $20,000 balance to your lifetime exemption. This also involves reporting the gift on Form 709 to let the IRS know that what you’re doing.
Read More: The Pros and Cons of Estate Tax
A Possible Pitfall
The lifetime exemption straddles both estate taxes and gift taxes. It’s referred to as the Unified Tax Credit.
Each time you go over your $15,000 annual exclusion and you bump the balance to your lifetime exemption, this leaves less of your lifetime exemption to cover any estate tax that your estate might eventually owe. Of course, that’s really no hardship for most people at $11.4 million, and the exemption is also adjusted for inflation so it goes up to $11.58 million in 2020.
But there is one caveat here. The TCJA expires at the end of 2025, so the credit can potentially plunge back to 2017 levels at that time – somewhere in the neighborhood of $5 million plus inflation adjustments. Still, that covers a fair bit of giving and estate value.
Some Gifts Are Entirely Exempt
Finally, some gifts aren’t taxable at all. You can give everything you own to your spouse, either before or after death, without incurring a single dime of tax. This provision is called the marital exclusion, but your spouse must be a U.S. citizen. Otherwise, you’re limited to giving $155,000 a year as of 2019.
You can also pay unlimited medical or tuition bills for any individual, as long as you give the gift directly to the care provider or to the school. You can’t give it to an individual to pay for tuition or medical expenses or it becomes a gift.
And, of course, you can give to qualified charitable organizations all day long and no gift tax will come due. In fact, you’ll even get a tax deduction if you give this way.
Deck the Halls
So go ahead and spend away this holiday season, always assuming that your budget covers your generosity. Most people won’t find the IRS at their doors looking to collect a gift tax in January.
Santa is likely to take a big hit, however.
Read More: List of Charities to Donate To
- Charles Schwab: Sharing the Wealth – How the Lifetime Gift Tax Exemption Works
- Tax Policy Center: How Do the Estate, Gift, and Generation-Skipping Transfer Taxes Work?
- The Retirement Source: Estate Tax, Gift Tax, Exclusions
- IRS: Frequently Asked Questions on Gift Taxes
- IRS: IRS Provides Tax Inflation Adjustments for Tax Year 2020
- Charles Schwab: The Estate Tax and Lifetime Gifting
- Chernoff Diamond: 2019/2018 Federal Estate and Gift Tax Tables
- Internal Revenue Service. "Frequently Asked Questions on Gift Taxes." Accessed April 30, 2020.
- Internal Revenue Service. "2019 Instructions for Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return." Page 8. Accessed April 30, 2020.
- Internal Revenue Service. "2019 Instructions for Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return," Page 3. Accessed April 30, 2020.
- Internal Revenue Service (IRS). "Publication 559: Survivors, Executors and Administrators: Estate and Gift Taxes." Page 26-27. Accessed April 30, 2020.
- Internal Revenue Service. "What's New - Estate and Gift Tax." Accessed April 30, 2020.
- Internal Revenue Service. "Estate and Gift Tax FAQs." Accessed April 30, 2020.
- Federation of American Scientists. "Recent Changes in the Estate and Gift Tax Provisions." Page 1. Accessed April 30, 2020.
- Center on Budget and Policy Priorities. "Ten Facts You Should Know About the Federal Estate Tax." Accessed April 30, 2020.
- Internal Revenue Service. "Instructions for Form 706: Time for Payment." Accessed April 30, 2020.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.