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What Gifts Are Subject to Gift Tax?

What Gifts Are Subject to Gift Tax?

The federal gift tax is intended to prevent taxpayers from disposing of their assets tax-free during their lifetime, which would prevent their assets from being subject to tax on death. For this reason, the tax itself focuses on the donor, not the recipient.

Learn more about how federal gift tax works and whether it applies to your donations.


How does the federal gift tax work?

The federal gift tax applies to financial gifts of value given by one party to another. It does not intend to regulate daily donations.

Because it aims to prevent people from escaping inheritance tax in the event of death, the gift tax is paid by the donor and not by the gift recipient. It also does not apply to all donations made during their lifetime.

People are free to donate money or goods in relatively small steps. If you send your grandchildren a check for a few hundred or even a few thousand dollars, it is not subject to the gift tax. Similarly, if you pay for a friend or relative to travel, gift tax will also not be triggered. You can also give more valuable gifts as they are exceptions to the usual rules.

Instead, the gift tax applies to huge financial gifts worth thousands of dollars. These can either be cash gifts or items that would otherwise cost a lot of money, such as a car or a new house.


Timing of Taxable Gifts

Gifts are taxable in the year you give them. For example, if John writes a check for $35,000 for his child in December 2022, he must report it on his 2022 tax return (filed in 2023), regardless of when he files it. If John does not deposit it until January 2023, the taxable portion of the donation will still be taxable in 2022.


Loans and Canceled Debts

Part of that $35,000 check is still taxable if John gave it out as a loan but does not get charged the applicable federal interest rate. The "gift" in this instance is the difference between the rate you receive and the current federal rate.

This rule only applies to loans over $10,000 unless you "forgive" the debt and refuse to be repaid. In this case, the portion of $25,000 that does not qualify for exemptions or exclusions becomes taxable.


What is considered a gift for tax purposes?

It can be difficult to understand what counts and does not count as a gift when it comes to tax purposes. Whether a gift is taxable or not depends on three factors:

  • Who receives it

  • Its FMV (fair market value)

  • Whether it is a gift of current interest or a gift of future interest


The recipient of the gift

Some people fall into exempt categories, which means you don't have to pay tax for the gifts you give. For individuals, this is based solely on their relationship with you. For institutions, it depends on the tax status of the organization.

All gifts given to your spouse are exempt from federal gift tax if your spouse is a US citizen. The unlimited federal spousal deduction allows spouses to give property to each other tax-free, before or after death.

For the year 2022, you can give up to $164,000 per year to a non-US spouse. This limit is periodically revised according to inflation.

Although certain rules apply, donations to qualifying political and charitable organizations are also fully exempt. For example, gifts given to political organizations must be for their use.

While gifts to your spouse are exempt, gifts to your children, grandchildren, other relatives, or friends are not. The only exceptions to this rule are medical expenses and tuition fees. You can pay your medical bills or tuition fees without limiting or incurring gift tax.

However, you must make direct payments to their caregiver or educational institution to do this. It's considered a gift if you give a check to a friend or relative or pay their credit card bill, even if the money is for medical or educational expenses.


Market Value

A gift is anything worth of value that you give without receiving Fair Market Value (FMV) in return. The IRS defines FMV as what they would have paid for an item or asset if neither the buyer nor the seller had been under pressure to complete the transaction.

The value of a gift is evident if it is given in cash and if you give someone $15,000 and get nothing in return. But you are considered to have given a gift of $250,000 if you sold someone a $500,000 house for $250,000. This is because you received nothing in return for half the property's value or the remaining $250,000.

Fair Market Value is generally the appraised value of a gift or a value comparable to other similar items sold simultaneously and under the same conditions.


Present interest versus future interest

A gift of current interest is a gift that the recipient can use, enjoy, and benefit from immediately. It comes unattached. It is a gift of future interest if the recipient cannot use it and fully enjoy it until some time. This distinction is important. 

Common examples of future interest gifts are setting aside an asset for life or funding a fund. However, your beneficiary generally does not become a full and vested owner until your death.

Future interest-bearing donations are taxable and must be reported to the IRS on Form 709, the US Gift (and Generation-Skipping Transfer) Tax Return.


How much can I donate, excluding tax?

Not all donations are taxable, even if they meet these criteria. Whether you have to pay taxes on your donation depends on its value.

Federal law excludes the first $16,000 you earn per person per year in 2022. Only the balance of the gift value over $16,000 is taxable. You can apply it to donations made to anyone other than your spouse, like their children.

This annual gift tax exclusion can be periodically increased by $1,000 in stages to keep up with inflation, but this is not always the case.

For example, if you give your child a one-time gift of $126,000 to buy a house, $16,000 of the gift would be free and exempt from federal gift tax. The remaining $110,000 would be considered a taxable donation.

If you give your child/dependent $16,000 in December of the previous year and another $52,000 in January, you will only pay tax on the $16,000 donation. The $16,000 from December of the previous year would be exempt, as would half of the amount ($26,000) you gave out in January.

This limit only applies per individual. So, if your child was married, you could give her and her spouse $16,000 each. This will allow you to give twice as much without incurring a gift tax. And if you're married, you and your spouse can give each person $16,000. This would enable you to give a total of $64,000 tax-free to your daughter and her partner.


What is a Lifetime Gift Tax Exemption?

The federal tax law also provides a lifetime gift tax exemption, but it is divided by the estate tax. This lifetime exclusion is sometimes called a "unified tax credit" because it covers both taxes. The cap is $12.06 million in 2022, up from $11.7 million in 2021.

You can pay gift tax on the balance of a gift beyond the $16,000 annual exclusion, or you can apply the balance against this lifetime credit. No gift tax is due, but the value of a gift is deducted from the exemption each time you make it. This leaves less to protect your assets from taxes applicable at the time of your death. However, only very important properties should be affected by this rule.


When are tax returns due?

Your gift tax return is due April 15 of the year following the date you made the gift. You will need to submit Form 706 and any related changes or schedules.


How much is the gift tax?

The gift tax rate depends on the value of your donation. These range from 18% for gifts with a taxable value of less than $10,000 to 40% for gifts with a taxable value of more than $1,000,000.


Summary

  • The tax status of a gift depends on its fair market value, the recipient, and its present or future use.

  • The first $16,000 that a person gives to another person is exempt from gift tax during the fiscal year.

  • Charitable donations, gifts to a spouse, and payment of medical expenses or school fees are not subject to the gift tax.


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