A guest post by Robert D Flach, the internet’s “Wandering Tax Pro”
In addition to federal income and payroll (or self-employment) tax Americans may also be subject to federal estate and gift taxes.
The estate tax is assessed on the net value of what a deceased person leaves behind – the individual’s assets (bank accounts, stock and mutual fund investments, pension plan balances, real estate, furniture and fixtures, collectibles, etc) less any outstanding liabilities (mortgage interest, auto, pension or personal loans, credit card balances, etc).
Most estates do not pay any federal estate tax, or have to file an estate tax return, because (1) all items left to a spouse are exempt from the tax, and (2) the current estate tax exemption is $2 Million. The estate of a person who goes to his/her final audit in calendar year 2008 will only pay estate tax on net assets in excess of $2 Million. If the value of the estate is $1.5 Million there is no tax. If the value, less allowable deductions, is $2.5 Million the executor would only pay tax on $500,000.
This exemption amount goes to $3.5 Million in 2009. In 2010 the federal estate tax is supposed to be repealed altogether, only to return again in 2011 with a $1 Million exemption.
The gift tax is a “spin-off” of the estate tax. Its purpose is to make sure that individuals do not give away all of their assets before death to avoid paying estate tax.
The gift tax is one of the most misunderstood of all taxes.
First of all, the gift tax is imposed on the “giver” (or “donor”) – the person making the gift – and not on the person receiving the gift (the “donee”).
Secondly, a gift has no affect on federal or state income taxes. Over my 35+ year career as a tax preparer I have heard many times something along the lines of, “I read somewhere that I can give my son a gift of $XX,000 each year. If I do this will it help reduce my income tax?”. The answer if always “no”. You cannot deduct a gift on your 1040, nor does the recipient of a gift report it on his/her 1040 as taxable income.
What the clients were talking about is the annual “gift tax exclusion”, currently $12,000. You can give $12,000 to as many individuals you want – relatives, friends or even strangers – in calendar year 2008 with no gift, or future estate, tax consequences.
The exclusion is annual – you can give $12,000 to your nephew in 2008 and another $12,000 to him in 2009. You can give $12,000 (or the appropriate exclusion amount) to him every year for the rest of your life and never have any gift tax, or estate tax, consequences
This annual amount is indexed for inflation, and is increased in increments of $1,000. Even though it is annually indexed, the current $12,000 exclusion amount will not increase until the accumulated inflation adjustment reaches $1,000.
If you have 10 grandchildren you can give each of them $12,000, a total of $120,000, and not have to pay any federal gift tax on the $120,000. These gifts will also have absolutely no affect on the eventual federal estate tax return, if one is required. Your spouse can also give away $12,000 per person per year. So grandpa and grandma can reduce their combined estate by $240,000 by, as a couple, giving each of their 10 grandchildren $24.000.
As a reminder – grandma and grandpa cannot deduct the $240,000 on their 1040, and the grandkids do not have to report the income on their federal income tax return.
If you make gifts to an individual that total more than $12,000 in one year you still do not necessarily have to pay any current gift tax. You can apply the excess gift to your lifetime gift tax exclusion amount, currently $1 Million. You can give up to a total of $1 Million in gifts that exceed the annual exclusion limit during your lifetime before you will owe any gift tax.
The annual gift tax exclusion of $12,000 and the lifetime exclusion amount of $1 Million are two separate exclusions – one has nothing to do with the other.
The lifetime gift tax exclusion amount is supposed to be the same as the federal estate tax exemption (see above), but under the “Economic Growth and Tax Relief Reconciliation Act of 2001” this amount was for some reason “frozen” at $1 Million. So, even though the federal estate tax exemption is currently $2 Million, the lifetime exclusion for gift tax purposes is only $1 Million.
Let us say you and your wife give your son and daughter-in-law a gift of $100,000 to use as downpayment for the purchase of a home. The first $48,000 will be exempt from gift tax consideration under the annual $12,000 per person exclusion (father + mother + son + daughter-in law = 4 x $12,000). The remaining $52,000 is a “taxable gift”. However you and your wife have never given any gifts in excess of the annual exclusion in the past. You would each file a gift tax return (IRS Form 709) to apply $26,000 to your lifetime exclusion amount, leaving you each with a remaining exclusion of $974,000.
In the above example, where you are making a gift for the downpayment on a home, the bank that is writing the mortgage for the home purchase will probably want to see a copy of the gift tax return to verify the source of the large downpayment. This has happenned to my clients in the past here in New Jersey, although it was not required for a similar situation in New York State. The bank will want to make sure that the downpayment did not come from drug money or terrorist sources.
The following items are not considered to be taxable gifts, and do not count toward the $12,000 per year annual exclusion or reduce the $1 Million lifetime exclusion amount –
* the support of a member of your household,
* gifts made to a spouse,
* college tuition paid directly to the educational institution for another person, and
* medical expenses paid directly to the provider (doctor, dentist, hospital, therapist, etc) on behalf of another person.
The gift tax also does not apply to gifts to political organizations or campaigns or to gifts to church and charity.
Here are three examples taken from IRS Publication 950 (Introduction to Estate and Gift Taxes) –
“Example 1. In 2007, you give your niece a cash gift of $8,000. It is your only gift to her this year. The gift is not a taxable gift because it is not more than the $12,000 annual exclusion.
Example 2. You pay the $15,000 college tuition of your friend. Because the payment qualifies for the educational exclusion, the gift is not a taxable gift.
Example 3. In 2007, you give $25,000 to your 25-year-old daughter. The first $12,000 of your gift is not subject to the gift tax because of the annual exclusion. The remaining $13,000 is a taxable gift. . . . you may not have to pay the gift tax on the remaining $13,000. However, you do have to file a gift tax return.”
If you give a gift of cash you obviously know what it is worth. A check to your grandson for $10,000 represents a gift of $10,000. But what if you give a gift of property – stock, real estate, etc? How is that gift valued for gift tax purposes?
The value of a gift of property is the “fair market value” of the gift on the date the gift is made (aka “date of transfer”). According to the IRS website – “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts”.
Say you make a gift to your nephew of 100 shares of FLACH CORPORATION stock on August 3rd. You determine that the price of a share of FLACH CORPORATION stock on August 3rd was $100. The value of the gift is $10,000.
As a point of information – the value of a gift for gift tax purposes for the gift giver is not the same as the tax basis of the gift for income tax purposes for the recipient of the gift. But that is the subject for another guest post – if the Baglady invites me back.
The above was a basic overview of the oft-confusing federal gift tax. I hope you have found it to be helpful. If you have any questions or want additional information I suggest you consult your tax professional. If you do not currently use a professional tax preparer you can find one in your area at www.taxprofessionals.com or by going to www.naea.org and clicking on “Find an Enrolled Agent” under the category “For Taxpayers” in the left hand margin.
TTFN
COPYRIGHT © 2008 BY ROBERT D FLACH LLC
Links –
www.irs.gov/publications/p950/ar02.html#d0e226 = IRS Pub 950 Introduction to Estate and Gift Taxes
www.irs.gov/pub/irs-pdf/f709.pdf = Form 709
www.irs.gov/businesses/small/article/0,,id=108139,00.html = IRS FAQ Page on Gift Taxes
Robert D Flach has been preparing 1040s for individuals in all walks of life, from professional athletes and actors to architects and doctors to secretaries and clerks, since 1972. He writes the popular tax blogs THE WANDERING TAX PRO (http://wanderingtaxpro.blogspot.com) and THE FLACH REPORT (http://theflachreport.blogspot.com).
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8 comments ↓
a very good posting.
What a great post. It’s hard enough for freelancers to figure out the basic taxes sometimes … it can feel impossible to actually feel as though you are really aware of and taking care of everything that you need to. Informative posts like these help us figure those things out in bite sized pieces.
[...] I also want to thank TWTP for introducing me to The Baglady and would like to point out that he has a guest post there that is a must read by all. Please check out Gift Tax 101. [...]
[...] If you haven’t already done so check out my guest post on “Gift Tax 101” at THE TAX LADY [...]
Rightly said sometimes it’s quite confusing with the tax systems and its functions.
Reading interesting posts like this is really enlightening at the end of the day.
Than you. You answered my questions on gift tax.
However; Just to be sure:
Example 1.
NO tax (gift or estate tax later on) if I were to give a son and daughter 10,000 each year (20,000) for a period of 50 years.
Example 2.
Gave stock to children valued at the time of gift of 200,000 filed 709 wife gave in same amount, Wife deceased and her estate did not exceed 1,000.000 even adding back the gift of stock (Stock has no present value) My estate will not? include her gift would not add back any of the annual gifts but would add back the 200,000 and still not reach 1,000,000 is there an estate of gift tax involved ??
This was very helpful. Thank you.
Thank you for the post.
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