Posted by Income Taxes and Bookkeeping LLC

All About Gift Tax: Do I Pay Tax on Parents' Gifts?

All About Gift Tax: Do I Pay Tax on Parents' Gifts?

Don't worry about gift tax if you've recently received a sizable gift from your mom and dad. The IRS generally holds the donor responsible for taxes. Except the person is donating a small fortune, they shouldn't even have to pay gift tax.

But if your parents are generous, you might want to know how the IRS views money and gift transfers. This piece will help you understand everything about gift tax. But because the rules for calculating gift tax can be complex, your parents should consult a financial advisor if their donation could generate a tax bill.

For the fiscal year 2020 and 2021, a person can donate up to $15,000 per person without notifying Uncle Sam. But even if your dad is above that level, you may only have to send a few documents. Normally, your parents shouldn't be paying out-of-pocket tax unless the year's gift takes them beyond the lifetime gift tax exclusion. For fiscal 2020, it is at $11.58 million.

What is the gift tax?

The Internal Revenue Service may impose a gift tax on someone who transfers money or property to another person without receiving anything of at least the same amount in return. However, this action depends on the quantity. The IRS essentially ignores gifts that do not violate the annual gift tax exclusion.

For 2020 and 2021, the annual tax exclusion for donations is $15,000 ($30,000 for couples filing together). This means that your dad can give you and anyone else $15,000. But assume your father gives you $20,000 as a wedding gift. At this point, he made a taxable donation. But that doesn't necessarily mean you have to write a check to the IRS that year for his gift. However, you must complete a gift tax return and complete IRS Form 709.

The government needs this to keep track of your parent's lifetime gift tax exclusion, and this is where many people get it wrong. But the rules are pretty straightforward. Let's take a look at this.

How does the Lifetime Gift Tax Exclusion Work?

For the fiscal year 2020, the lifetime gift tax exemption stands at $11.58 million ($23.16 million for couples filing together), $11.7 million, and $23.14 for couples filing jointly). 

The annual gift tax exclusion is an addition to the lifetime donation tax exclusion. So, suppose your dad gives you a total of $25,000 in cash for 2020. He must file IRS Form 709 because he has exhausted her annual exclusion of $15,000 for the year. But you probably don't owe taxes for this gift. The excess amount ($25,000 - $15,000 = $10,000) simply reduces the value of the lifetime gift tax exclusion.

This translates to $11.58 million minus $10,000 = $11.57 million. So he can continue to give gifts and only worry about the extra paperwork. Unless he intends to gift beyond the limit of $11.58 million in his lifetime, he is in the clear.


What is the 2021 Gift Tax Exclusion?

Uncle Sam recently declared that the annual gift tax exclusion for fiscal 2021 would remain at $15,000 for individual taxpayers and $30,000 for couples filing jointly. The lifetime gift tax exclusion will also remain at $11.58 million ($23.16 million for couples filing jointly).

However, it is important to note that exclusion on lifetime gift taxes has not always been so high. It has increased considerably since the signing of the TCJA (Tax Cuts and Jobs Act). Often referred to as the Trump Fiscal Plan, these tax cuts are expected to expire at the end of 2025. However, some lawmakers are pushing for them to be permanent. However, political changes could affect the provisions of this massive tax reform before that date. Therefore, it is important to follow up and seek the help of a financial advisor or tax expert when it comes to the gift tax.

What does it matter about gift tax?

The IRS never taxes any specific transfer of money or property, regardless of its value. You can avoid gift fees by gifting to:

§ Political organizations

§ School and medical expenses on behalf of another person

§ Spouse

When paying someone's tuition or medical bills, it's best to send those payments directly to the institution to avoid problems with the IRS. So if you have tuition fees and your parents want to pay them, tell them to send the money directly to the school. If they send the money to you first, they will probably need to fill out a few more documents. They can also reduce the exclusion from the lifetime gift tax, which they could easily avoid.

Who pays the gift tax?

If a gift generates an actual IRS tax bill, the person responsible for payment would be the donor. The IRS may collect a gift tax from the recipient if the donor chooses not to pay it in rare cases. But if your parents are really generous to pay an amount that pushes them past the lifetime gift tax exemption, they'll likely have enough money to cover the tax bill.

However, there are several ways the wealthy can avoid tax on donations. This includes careful property planning strategies, using a proper trust, and exploiting exclusions to provide money to students.

This can be helpful if your parents are investing in a 529 education savings plan.


How much is the Gift Tax?

If your parents don't owe out-of-pocket gift taxes to the IRS, the rate typically ranges from 18% to 40%. However, the IRS sets some specific rules and allows certain exceptions when it comes to handling gift taxes. Your parents can find out more about how this affects their specific situation by reviewing the instructions on the IRS 709 form.

How to avoid gift taxes?

If your parents invest in a 529 plan to fund your college education, they can take advantage of gift tax exclusive to these savings vehicles.

Provided they make a special election, they (your parents) can make a one-time contribution to a 529 plan up to five times the annual gift tax exclusion and can avoid gift tax. As mentioned earlier, this limit is $75,000 ($150,000 if you are married filing jointly) for the 2020 fiscal year. The special election means that your parents are asking the IRS to treat this contribution as a period of one year.

So, suppose your parents will contribute a total of $75,000 to your 529 plan in 2020. This triggers the gift tax. But, as with a 529 plan, the IRS can treat it as $15,000 earned over five years. Thus, your parents avoid violating the annual tax exemption on gifts. Therefore, the 529 plan contribution of $75,000 will generally not reduce the lifetime gift tax exclusion. The only condition is that your parents do not contribute to the plan for the next five years. They can claim it on a federal gift tax return.

However, if your parent dies during that five-year period, the IRS considers the remaining parts to be part of the parent's gross federal assets for tax purposes.

Suppose your parents chose the special five-year rule but died in the second year. The first two installments of the one-time contribution of $75,000 ($15,000 x 2 = $30,000) are not considered for your parents' estate. However, the rest ($45,000) will. Additionally, some states have their own property tax rules.

If your parents need help taking advantage of the gift tax exemptions for 529 plans, a financial advisor or chartered accountant (CPA) can help.


Bottom Line

Chances are, you won't be liable for gift tax on a gift from your parents. Depending on the amount, your parents may be required to file an income tax return. If they gave you or someone more than $30,000 in 2020 ($15,000 per parent), they must file certain documents.

You normally will not have to pay any out-of-pocket gift taxes unless your parents exceed their lifetime gift tax. This factor is currently $11.58 million ($23.16 million for couples filing jointly). But if you owe gift taxes, you can pay them up to 40%.

The actual tax on gifts only affects a small part of the population because of the high limit. 



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