Q: Tax Playa, my grandfather gives my sister and me $10,000 every year. Will he or I have any taxes to worry about because of this?
Melanie, Alexandria VA
A: The first $12,000 of gifts in 2007 to any person from any person are free of any tax consequences. Above and beyond this, gift tax must be calculated, and a lifetime exclusion called the "unified credit" is drawn down. If the unified credit is breached, gift tax is owed.
For more information on the gift tax, see IRS Publication 950, Introduction to Estate and Gift Taxes.
The first thing to say is that recipients of gifts never have to pay tax on them. This is a question I get a lot, and for good reason--it seems like income. It's important to note, though, that the donee's basis in the gift is usually the donor's adjusted basis in the asset (or fair market value, if lower). This is important, because if the donor dies and bequests the assets to the heir, the latter benefits from the asset's basis being stepped-up to the fair market value of the date of death (or the adjusted basis, if higher).
Any incidence of taxation on gifts takes place on the level of the giftor. The donor of the gift is responsible for paying a gift tax whose brackets range from 18% to 47%.
There are three major ways that this gift tax can be avoided, though:
- Not All Gifts Are Taxable. These tax-free gifts include tuition or medical expenses to a school or medical facility, gifts to your spouse, gifts to a political organization for its use, and gifts to charities (which may not only be tax-free, but deductible).
- Not All Taxable Gifts Are Taxable. As I said above, the first $12,000 of gifts from any one person to any one person per year is tax-free. Thus, a married couple could give $24,000 per year to each child. There is also a special rule allowing a five-year gift exclusion to a 529 college savings plan in one year (meaning a person could gift a $60,000 529 plan contribution in one year and take the next four years off).
- Taxable Gifts Get A Unified Credit. Even if you give a taxable aggregation of gifts above the gift limit, you can still take a lifetime credit against gift tax. This allows up to $1,000,000 of taxable gifts to be free of tax in the donor's lifetime.
There is no need to file any special tax forms if the donor's gift is non-taxable, or if the donor is giving gifts at less than the gift tax annual exclusion of $12,000 (which is indexed to inflation in $1000 increments).
If, however, the annual exclusion is breached and the unified credit must be applied, or actual gift tax must be paid, Form 760 must be filed. This is a rather complex form and can be expensive to process (I've never done one), so try to avoid it. If you are a donor and you have a desire to gift assets to your family or friends, use the following techniques:
- If you have a spouse, gift assets to her sufficient for her to in turn gift on her own to the people you want to receive gifts. This allows you to avoid the "gift splitting" rules which may require a tax filing. Remember that the limit is $12,000 from any one person to any one person. And gifts to a spouse have no limit.
- Use the 529 plan loophole. Both you and your spouse can give $60,000 this year to a 529 plan. So, a good way to quickly divest of assets and ensure a quality education for a grandchild is to give a combined $120,000 to a 529 plan in one year. Of course, any birthday or Christmas presents would then be liable for the unified credit exclusion and filing.
- Make gifting an annual exercise. If you have hundreds of thousands of dollars to gift, just keep plugging away. Over time, not only will you gift most of your assets tax-free, you will substantially-reduce any possible estate tax liability since your estate will be largely-divested.
- Use the exclusion. Since you can exclude $1,000,000 in gifts, use it. It will require one or more years of filing Form 760, but if you feel like you won't be able to divest your estate tax-free before your death (and especially if you anticipate an estate tax liability), use the credit the law makes available to you.
Needless to say, this should just be a starting point. If you have assets of the size to worry about this stuff, get an expert. That isn't your friendly neighborhood tax preparer, either--get an estate and gift tax lawyer or other accredited specialist.