Learn about the basics of gift tax limits and how it works with estate tax here.
In this article:
- What Is a Gift Tax?
- Who Pays the Gift Tax?
- How Much Is the Gift Tax Limit for 2018?
- Is This Different from the Lifetime Gift Tax Limit?
- How Can the Annual Gift Tax Limit Affect Your Lifetime Gift and Estate Tax Exclusion?
- What Presents Are Exempt from Gift Tax Limits?
2018 Gift Tax Limits | The Basics of Gifting and Its Taxes
What Is a Gift Tax?
Before you proceed to learn more about the gift tax limit, let’s define gift tax. It is a federal (and/or state) tax levied on a transfer of property from a donor to a donee. The activity is not a form of exchange. The recipient doesn’t have the responsibility to give something in return. They don’t need to accept the gift either.
These properties also remain taxable gifts even if the recipient decides to give something. The general rule is it should not have a value higher than what the donor gave.
Any gift may be taxable. These can include the following:
- Cancellation of a debt
- Payment of another person’s loan
- Personal gift to a corporation
- Loan of $10,000 or more
The rules can vary on the different types of tax gifts. For example, loaning someone at least $10,000 is a gift if the interest is less than the market rate. The states may also have their own respective qualifications. When in doubt, always reach out to experts to avoid facing tax consequences later.
Who Pays the Gift Tax?
In general, it is the giver and not the recipient who pays the tax and files the income tax return. They use the Gift Giving and Generation-Skipping Transfer Tax Return (IRS Form 709) for this. In exceptional cases, both parties can agree the recipient pays it on behalf of the donor. This often occurs when the former reaches their tax-free gift limit. The giver settles the tax liability the following year after they gave the gift on or before April 15.
How Much Is the Gift Tax Limit for 2018?
The IRS periodically sets a gift tax limit, and it’s indexed for inflation. In other words, it can increase every year. From 2014 to 2017, the agency imposed a gift tax to presents that exceeded $14,000 in value. It tends to increase by $1,000 each year. During this period, though, there was no increase since the inflation rate was low.
The gift tax exclusion for 2018 increased to $15,000. The limit applies per recipient. You can still give up to $15,000 worth of gifts to more than two persons without having to pay a gift tax.
A U.S. non-resident alien can also take advantage of the limit as of January 1, 2018. Married couples can make a split gift. Each can have a limit of up to $15,000, which means their total gift can be $30,000. Both need to agree on the present and file their respective tax returns.
Is This Different from the Lifetime Gift Tax Limit?
Elder Law Word of the Week – Federal Gift Tax. This federal tax is imposed on transfers of property during lifetime. pic.twitter.com/lDbKKeFgHU
— Gregory Gay, Esquire (@willtrustplan) May 5, 2016
Yes. The IRS has what you call the unified tax credit. It is a system that combines estate and gift tax. Both of these are separate types of taxes. The estate tax is the amount levied by the government according to the net value of your total assets. You pay it before you can distribute your properties to any heirs. They are interconnected, though. It’s not uncommon for people to give away their properties before they die as gifts.
The unified tax credit provides a lifetime gift tax limit to prevent abuse. However, you can work it to your advantage. The gift and estate tax exemption under this credit is enormous. The new tax reform law increased it to a whopping $11.2 million per person starting in 2018. Married couples, thus, can use up to $22.4 million. You can maximize it to shelter your assets from the hefty federal estate tax and gift tax rates, which can be up to 40%.
The IRS follows a simple computation to arrive at your taxable estate. It determines your gross estate first and then reduces it with tax deductions. These may include any existing debt and contributions to charity. Then it adds the taxable gifts since 1977 before it deducts your unified tax credit.
If you have assets below $11 million and you didn’t use your gift and estate tax exclusion to lower your gift tax, then you’re in luck. You may not have to pay estate tax after all. You can also use this amount while you’re still alive or an authorized person can disburse it after death.
How Can the Annual Gift Tax Limit Affect Your Lifetime Gift and Estate Tax Exclusion?
The annual gift tax exemption can help prevent you from maxing out your lifetime gift tax exclusion. You can give no more than $15,000 to as many people as you like. Then you don’t need to pay gift taxes at all. The dynamics change once you go beyond this amount, though.
Let’s pretend you gave a total of $2.5 million as gifts to eight of your relatives. You don’t need to pay for the $120,000 due to the exclusion rule. It leaves you with $2.38 million of taxable gift, though. If the tax rate is 40%, your gift tax can be almost a million! You can then tap into your lifetime exemption and avoid paying the large amount due.
It may seem like you won, but it has a significant downside. You are eroding your estate tax shelter. Your family could end up paying way more once you die.
What Presents Are Exempt from Gift Tax Limits?
The gift tax does not cover all types of presents. The following may be exempt from it:
- Amount paid to an educational institution or medical expenses you pay for someone
- Gifts to the spouse who is a U.S. citizen
- Contributions to a political organization (for official use)
- Donations to qualifying charities
There are also variations to the rules for the non-taxable ones. For instance, the tuition is a tax-exempt present for someone if you give it directly to the school.
If you have considerable assets, you need to know the gift tax limit by heart. The same is true if you are accumulating wealth or want some tax relief. This knowledge allows you to keep track of the value of the items you give and whether you owe tax. The rules, though, can be confusing. If you need help, work with a tax planning attorney or specialist. They can guide you on how to maximize these tax benefits.
Do you think the gift tax limit is fair? Send us your thoughts in the comments section below.
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Editor’s Note: This post was originally published on December 18, 2017, and has been updated for quality and relevancy.