Gift or Party?
When Do Gift Tax Rules Apply
Since you are not an elected official or a judge, you don’t have to worry about the ethics violations related to accepting luxury travel like Supreme Court Justice Clarence Thomas. But you should understand gift tax law and how you can use it to your advantage.
What is the gift tax?
The U.S. gift tax was created in 1924 as a fix to an estate tax loophole. To prevent wealthy Americans from shrinking taxable estates by transferring assets to others before death, the tax kicks in above a lifetime exemption that applies both to an individual’s total taxable gifts made during life and assets left at death. Currently, the top gift/estate rate is 40%, and the giver, not the recipient, owes the tax.
What is considered a gift?
The IRS definition is the transfer of cash, assets or value “for less than adequate and full consideration,” according to the law. “Consideration” often means money, but it could be other assets. So, all the following would be considered a gift:
You write a check for $10,000 to your grandchild.
You sell your child your business for less than it’s worth, the difference could be a gift.
You buy your son a car.
Are there gift-tax exemptions?
Gift Tax Payment Exemption.
You don’t start paying tax on gifts until your lifetime gifts exceed the estate tax exemption. For 2023, that amount is $12.92 million per individual, or $25.84 million per married couple. So while the lifetime exemption wipes out federal gift and estate taxes for all but the wealthiest, you still must file a gift tax return if your gift does not meet one of the exemptions below
Gift Tax Filing Exemptions.
The most common and useful exemption is the annual tax-free gift exclusion. Each person can make tax-free gifts annually to other individuals, whether they’re related or not. For 2023, the limit is $17,000 per giver, per recipient. So a married couple with two married children and three grandchildren could make total tax-free gifts of $238,000 this year to those seven relatives, plus $34,000 to as many other individuals as they want. No gift-tax return needs to be filed for annual gifts below the $17,000 threshold.
Transfers between spouses are typically tax-free if both are U.S. citizens.
Payments of another’s tuition or medical bills are generally not subject to gift tax but must be made directly to the school or care provider.
While there is still a filing requirement, you can “bunch up to five years of annual gifts when contributing to a 529 plan. A married couple could fund a child’s or grandchild’s 529 with $170,000 in 2023 and it would not reduce the lifetime exemption.
This sounds great but how does it work in reality.
1) I give my son $30,000 to help with the down payment on a new home.
If you give it in a lump sum, then in many cases you would need to file a Form 709 gift-tax return with the IRS. While $17,000 could count as a tax-free annual gift, the other $13,000 would be deducted from your lifetime exemption.
But you could avoid the need to file if you give up to $17,000 this year and the other $13,000 early next year. Or if your child is married, you could split the gift between the child and spouse to stay under the limit.
You could also fund your child’s 529 early in their life, let it grow and then use the new tax law to let them convert it to an IRA, which can be used to purchase a first home without penalties. We will cover that option in a future blog.
2) I give my husband a fancy new watch for his birthday.
If you are both US citizens, no filing or payment is required regardless of the price.
3) I give my daughter the 1968 Chevy Camaro that she helped me restore and is currently worth $45,000.
You are an awesome parent but the tax treatment depends upon the circumstances.
If you are still legally obligated to support your child (under 18 in most states), then the car could be part of the support and therefore free of gift tax.
If you waited until your child was in their 40s for fear they would wreck the car at a younger age, the first $17,000 (for 2023) would be exempt but you would be required to file a gift tax return for the remaining $28,000.
4) You pay some of the medical bills for your child’s teacher who is battling cancer.
You are an incredibly kind individual and your gift would not require the filing of a gift tax return if the payment was made directly to the hospital or doctor. If made directly to the teacher (even through a third party website like GoFundMe), you would be subject to filing requirement if the payments exceed the annual limit ($17,000 in 2023).
5) Your practice had a great year and you would like to gift your staff $5,000.
This is NOT a gift but compensation and must be included in payroll along with all other wages.
6) Finally, you love taking family and friends out on your boat (silly captain hats required).
There are no definitive Tax Court cases to rely on (although Justice Thomas may be the first), gift tax experts believe it comes down to hospitality. If you give somebody a week aboard your luxury yacht while you ski in Colorado, it is likely a taxable gift. If you are on board for the entire trip then it is not a gift but a party.
It is likely you will never pay gift taxes, but to avoid the need to file a gift tax return, you need to work with a qualified advisor to help you plan your gifting.