(MP) Surprise – your parents send you a nice check! Maybe it’s enough for dinner, or maybe it’s more of an “early inheritance.” Either way, do you need to worry about paying a gift tax to the IRS? The Internal Revenue Code imposes a tax on property or cash you give to any one person, but only if the value of the gift exceeds a certain threshold called the annual gift tax exclusion.
The IRS defines a gift as anything for which you don’t receive full consideration in return. If you sell a piece of property to your niece for $90,000, but the property appraised at a fair market value of $190,000, you’ve given a gift of $100,000. Fair market value is defined as what someone would reasonably pay for an item in a reasonable exchange when neither he nor the seller is under pressure to pay too much or sell for too little. Of course, cash is a dollar-for-dollar value against the exclusion.
Here’s another way the annual exclusion works. Say you gave your daughter $14,000 before Dec. 31, 2016, because this is an annual exclusion, then you can give her another $14,000 on Jan. 1, 2017, your gift is given without breaking the rules or incurring a tax. If you gave her $15,000 on Dec. 31, you would owe a tax on $1,000, the value above the exclusion amount at a potential top tax rate of up to 40 percent.
When the Gift is not an issue
The person who makes the gift files the tax return, if necessary, and pays any tax.
If someone gives you more than the annual tax exclusion amount ($14,000 in 2015 and 2016), the giver must file a tax return. That still doesn’t mean they owe the tax.
For example, say someone gives you $20,000 in one year, and you and the giver are both single. The giver must file a tax return, showing an excess gift of $6,000 ($20,000 – $14,000 exclusion = $6,000).
Every year, the amount a person gives other people over the annual exclusion accumulates until it reaches the lifetime gift tax exclusion.
Currently, a taxpayer does not pay the tax until they have given away over $5.43 million in their lifetime (2016).
Annual limits before the IRS takes notice
First, a contribution or present must be quite substantial before the IRS takes notice.
A gift of $14,000 or less in a calendar year (2015 and 2016) doesn’t even count.
If a couple makes a gift from a joint property, the IRS considers the gift to be given half from each. Mom and Dad can give $28,000 with no worries.
A couple can also give an additional contribution of up to $14,000 to each son-in-law or daughter-in-law.
The effective annual limit from one couple to another couple, therefore, is $56,000 ($14,000 X 4 = $56,000).
Gifts that don’t count
Some transfers of money are never considered to be gifts, no matter the amount.
For purposes of the tax, it’s not considered a gift if:
- It’s given to a husband or wife who is a U.S. citizen. Special rules apply to spouses who are not U.S. citizens.
- It’s paid directly to an educational or medical institution for someone’s medical bills or tuition expenses. (It doesn’t have to be a child, or even a relative, for this exception.)
Does the gift recipient ever have to pay the tax?
If the donor does not pay the tax, the IRS may collect it from you.
However, most donors who can afford to make gifts large enough to be subject to gift taxes can also afford to pay the tax on the gifts.