Understanding The Rules of Gifting
By Mishaela Albright, CFP®, CPA
While it might seem natural to just be able to give money freely to people you love...the rules are slightly complicated. Your heart is in the right place! There just might be some extra reporting you’ll need to do to the IRS.
When you are thinking of helping someone else financially it’s helpful to have an understanding of the basics.
In a nutshell: you can give any person up to $15,000 per year. If you give more than $15,000 in a calendar year, you will likely need to report it on an informational Gift Tax return. You probably won’t owe taxes right away, but the IRS needs to know about it.
Let’s talk this through and discuss some specifics.
Why do we have to report gifts, and when do we need to file a gift tax return?
Getting right into it – when you pass away, if your Estate is valued over $11.7M, it may be subject to Estate taxes (which currently has a max rate of 40%). Likewise, if you gift over $11.7M ($23.4M if married), you have exceeded the Lifetime Estate Tax Exemption, and any amount over that will be subject to tax.
In other words, in 2021, you can remove up to $11.7M from your Estate without incurring any tax. (Note – the newest legislation from the Biden Administration has proposed to bring this down to around $5.8M in 2022, see John’s post on this).
What exactly is an Estate? I’m sure you’ve heard of or been to an Estate sale, which typically has a random assortment of a persons lifetime possessions. Well, those random belongings, plus any real estate, financial securities, cash, or anything that you own or have a controlling interest in are considered part of your Estate. For some folks, the total worth of their Estate is well beyond the Lifetime Exemption, so they’ll want to pay attention to the gifting rules and try to optimize wherever possible.
With that being said, there are a few nuances to the gifting rules and some gifts you can make without counting against your Lifetime Exemption. The first one being that you can gift up to $15,000 ($30,000 if married and elected to gift splitting) on an annual basis, per recipient, without tapping in to your Lifetime Exemption.
When you gift over $15,000 during the year (whether it is a one-time gift or multiple gifts that are beyond this limit in aggregate), you are required to file a Gift Tax return to keep track of the accumulated gift amounts exceeding $15k. This means your Lifetime Exemption is reduced by the amount that exceeds the Annual Gift Tax Exclusion, which is what the IRS wants to keep track of and why they require the gift tax return to be filed.
The second comes in to play with 529 accounts and super funding your contribution. The quick 411 on this is that you can put 5x the amount of the Annual Gift Exclusion ($75k if single, $150k if married) into a 529 account and spread that gift over a five-year period. Check out AJ’s post on 529’s for more information on those accounts.
Keep in mind, if you are required to file the Gift Tax form, it does not mean that you or the borrower will have to pay taxes on the gift amount that was over the Annual Exemption. It is merely a way for the IRS to keep track of your total gifts in a lifetime. Once you have gifted beyond the Lifetime Exemption, then you (the gifter) will be liable for any gift tax due at that point.
The person receiving the gift does NOT have to file a gift tax return, the burden is on the person giving the gift.
To illustrate, here is a preview of the Gift Tax form, which requires the donor’s information only. Also, shown on this form is where spouses consent to gift splitting.
Frequently asked questions:
Is gifting between spouses allowed? If your spouse is also a U.S. Citizen, there is no limit to the amount you can ‘gift’ to each other. However, if they are not a U.S. Citzen then tax-free gifts to your spouse have a different annual exclusion threshold which is currently $159,000/year.
Do you have to limit gifts to your children or parents? There are no special rules that apply to these family members, so any gift would need to follow the same rules as described above.
What about paying for college or medical expenses for someone else? If paid directly to the organization, these types of payments are not subject to gift tax rules. However, if you give money to the individual for said expenses, that does not count and would require a gift tax return for amounts above the Annual Gift Tax Exclusion.
Do charitable gifts fall under these rules? No, other than any AGI limits/organization qualifications, you are free to donate to the charity of your choice without worrying about reducing your exemption. However, if you are otherwise filing a gift tax return, you should include charitable gifts as well.
What if you loan a family member money? Sure, you can do that, but the IRS mandates a few things, such as: you have a signed written agreement with a fixed repayment schedule, and you must charge a minimum interest rate (for loans over $10k or $100k and the borrower has more than $1k in net investment income). Regardless of if you actually charge and collect interest payments, you must pay taxes on the imputed gift. For example, if you were to loan your cousin $150k for a year, but did not charge her interest, you would have to recognize at least $300 in imputed interest income. This is based on the Oct. 2021 short-term Applicable Federal Rate (which the IRS publishes monthly).
What’s the moral of the story?
While there is the potential for huge changes to the gift tax landscape, most folks don’t pay any gift tax during their lifetime (and no estate tax at death) given their level of assets, proclivity to gift, and careful planning with professionals. If you’re uncertain about whether you’ve made taxable gifts or whether you should better optimize your gifting, you should speak with a qualified financial planner and/or estate planning attorney.