What is the Gift Tax?

Taxes 101

Did you know that the government imposes a tax on large gifts? This may come as a surprise to some. After all, you’re simply giving money away, usually to family, only to find out the government wants to tax you for doing so. You’re probably thinking that isn’t fair, but the tax was created to close a bit of a loophole.

The reason this tax comes into play has to do with the estate tax. Without a gift tax, someone could give away all or most of their money right before death as a way to circumvent the estate tax. Now, you may also argue that the estate tax also isn’t fair, but that’s a discussion for another day.

There is some good news. First, the amount of the gift that triggers the gift tax is relatively high which means most people will never have to worry about it. Second, the gift tax threshold is reset annually, and is on a per-person basis. For 2010 and 2011, that individual annual amount is $13,000. So, if you have two children and you wanted to give them each $13,000 you could without triggering the gift tax. To sweeten the deal even further, the gift tax is an individual one, so if you’re married, you and your spouse can each give $13,000 to an individual each year, bringing the annual total up to $26,000.

In addition, there is a lifetime exclusion. Through the 2010 tax year your annual gift tax exclusion is $1 million. Beginning in 2011 that exclusion goes all the way up to $5 million. So, you can actually use the lifetime limit to actually give a recipient even more than the annual limit without triggering gift tax in that tax year. Here’s how it works:

Let’s say you wanted to give each of your two children $20,000 this year. That’s more than the $13,000 per person annual limit. So what happens is you give them the $20,000, but then the $7,000 excess for each would then be applied to your lifetime limit. In this case that’s $14,000 total that goes against your lifetime exclusion. You’d still have to file the IRS gift tax form to record this excess, but you wouldn’t owe any gift tax on that money.

Gift Exclusions

The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.

  • Gifts that are not more than the annual exclusion for the calendar year.
  • Tuition or medical expenses you pay for someone (the educational and medical exclusions).
  • Gifts to your spouse.
  • Gifts to a political organization for its use.

For more information, check out this video by TurboTax: http://www.youtube.com/watch?v=nj9LNMHXamA