If you make large enough gifts to relatives or friends, you might owe the federal gift tax. Here are the basics on how the tax works.
The article below is accurate for your 2017 taxes, the one that you file this year by the April 2018 deadline, including a few retroactive changes due to the passing of tax reform. Some tax information below will change next year for your 2018 taxes, but won’t impact you this year. Learn more about tax reform here.
The gift tax only kicks in after lifetime gifts exceed $5.49 million in 2017
The first thing to know about the federal gift tax is that gift givers—not gift recipients—have to pay it. Thankfully, you won’t owe the tax until you’ve given away more than $5 million in cash or other assets during your lifetime.
The lifetime exclusion will be raised to $5.49 million in 2017. If you’re married, your spouse is entitled to a separate $5.49 million in 2017. So actually owing the gift tax is not a concern for most folks. But you may still have to file gift tax returns even though you don’t owe any tax. So please keep reading.
The annual gift tax exclusion provides additional shelter
The annual federal gift tax exclusion allows you to give away up to $14,000 in 2017 to as many people as you wish without those gifts counting against your $5 million lifetime exemption. (After 2017, the $14,000 exclusion may be increased for inflation.)
Say you give two favored relatives $20,000 each in 2017 and give another relative $10,000. The $20,000 gifts are called taxable gifts because they exceed the $14,000 annual exclusion. But you won’t actually owe any gift tax unless you’ve exhausted your lifetime exemption amount.
Assuming you haven’t, the two taxable gifts simply reduce your lifetime exemption by $12,000 [($20,000 - $14,000) x 2 = $12,000]. The $10,000 gift is ignored, because it’s below the $14,000 annual exclusion.
If you give three individuals $14,000 each in 2017, these gifts are ignored because they don’t exceed the annual exclusion.
Gift taxes and estate taxes are connected
You have a $5.49 million federal estate tax exemption for 2017, thanks to the 2010 Tax Relief Act signed into law by former President Obama. You can leave up to that amount to relatives or friends free of any federal estate tax. If you’re married, your spouse is entitled to a separate $5.49 million exemption. Beginning in 2011, the gift tax and the estate tax was reunified with an exclusion amount of $5.49 million for 2017.
Gifts made during your lifetime will reduce your taxable estate. However, gifts in excess of the annual exclusion also reduce your estate tax exemption. In the earlier example, the two $20,000 taxable gifts made in 2017 would reduce your estate tax exemption by $12,000 to $5,478,000 ($5,490,000- $12,000), based on the recently enacted changes in estate law. The $10,000 gift in 2017 and the three $14,000 gifts in 2017 would not reduce your estate tax exemption.
Bottom line: Making annual gifts up to the exclusion ($14,000 in 2017) is a good way to reduce your taxable estate without any negative side effects.
Special rule for 529 plan contributions
Contributions to a 529 college savings plan are gifts to the future student. However, a special rule allows you to make a lump-sum contribution and spread it over five years for gift tax purposes. For example, you can contribute $70,000 in 2017 to jump-start a 529 college savings account for your child. If you’re married, your spouse can do the same. You can spread the gift over 2017-2021 without incurring any gift tax and without reducing your $5.49 million lifetime gift tax exemption or your $5.49 million estate tax exemption. Your spouse can spread his or her $70,000 gift over five years as well. The only caveat: You can’t make any additional gifts to the same recipient during those years without using part of your $5.49 million exemption.
Some gifts are tax-exempt
Among others, the following types of gifts are exempt from the federal gift tax so you can make unlimited gifts in these categories without any gift tax or estate tax consequences and without having to file gift tax returns:
- Gifts to IRS-approved charities
- Gifts to your spouse (assuming he or she is a U.S. citizen)
- Gifts covering another person’s medical expenses, as long as you make the payments directly to medical service providers
- Gifts covering another person’s tuition expenses, as long as you make payments directly to the educational institution. (Payments for room and board, books, and supplies don’t qualify for this exception, but you can cover those costs by making a direct gift to the student under the annual exclusion.)
You many need to file a gift tax return
If you make a taxable gift (one in excess of the annual exclusion), you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return. The return is required even if you don’t actually owe any gift tax because of the $5.49 million lifetime exemption. The return is due by April 15 of the year after you make the gift—the same deadline as Form 1040. If you extend your 1040 to October 15, the extended due date applies to your gift tax return too.
If you’re married, you can’t file a joint gift tax return. Each spouse must file a separate return if he or she makes any taxable gifts. You can, however, choose to “split” gifts with your spouse. Making a split gift allows you to take advantage of your annual gift tax exclusion plus your spouse’s exclusion for a gift that is made entirely by you.
For example, say you gave $28,000 to your child in 2017. By treating it as a split gift, you can completely shelter the gift with your $14,000 exclusion plus your spouse’s $14,000 exclusion. That way no gift tax is due, and the gift doesn't reduce the $5.49 million lifetime gift tax exemption in effect for 2017 or the estate tax exemption for you or your spouse. If you choose to make a split gift, you must file Form 709, and your spouse must consent to the arrangement.
A bigger story
This article only covers the basics of federal gift taxes. For more information, see IRS Publication 950: Introduction to Estate and Gift Taxes. See also the instructions for Form 709. You can find these documents on the IRS website at www.irs.gov.
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