“Happy Birthday”, says the doting parent, sliding a small box, neatly wrapped in colorful paper and a bow across the table to her teenaged son. He opens it, and his face brightens. It just as he’d hoped – it’s his new iPhone! And not one of those old-fashioned iPhone 6s, it’s the new iPhone X! Day made – for him, anyway. Mom, however, now has to wrestle with the impact of the taxable transaction she just created.
There you go. Gifts, after all, are taxable events, according to the IRS. However, before we use that as a pretext for disappointing the kids on Christmas morning, let’s peel back a few more layers to this onion.
Gifts are taxable, but not to the gift recipient; rather, the person giving the gift is held responsible for tracking, reporting, and paying any taxes on the gift. Gifts may be exempted from taxation if they are made from one legally married spouse to another, or to a charitable entity. Children are not tax-exempted recipients. Gifts to your kids don’t receive any different treatment than is given to anyone else. Fortunately, money you pay to an educational institution for the education of these kids is specifically not considered a gift, and the IRS will not force you to measure and value how much food they consume. Basic food and shelter for dependent children falls outside the realm of ‘gifts.’
Additionally, in order to simplify things, the IRS also excludes from taxation up to $15,000/year (starting in 2018) in gifts to any person. This is doubled for a married couple that wants to jointly gift an asset. So gifts of less than $15,000 in a year (or $30,000 from a married couple) to any person or entity are just plain ‘non-taxable’. Basically, the IRS is only interested in gifts to non-spouses, and only to the degree that they exceed this limit.
Example: Lucy gives her son a $50,000 gift. Since Lucy is married, she can join with her spouse in exempting $30,000 from this gift and as a result has made a taxable gift of $20,000. Any other gift to this son during the calendar year will be considered fully taxable.
The $15,000 gift tax exclusion can actually be leveraged, as well. Money contributed to a 529 plan (for education) can be ‘front-loaded’ with five years of gifted contributions. That’s $75,000, completely gift-tax-free (although any other gifts during that five year period would be considered taxable).
One place where this creates some potential ‘issues’ is when non-married domestic partners live together with the majority of the income being made by one of the partners. Technically, since this is not a ‘marriage’, room and board provided by one partner to the other could potentially be considered a gift.
When a gift tax situation has arisen, form 709 must be filed. Two choices exist at this point: Gift taxes can be paid, but there is another option. Since gift taxes and estate taxes are unified into one tax system, the exemption that applies to estates also can apply to lifetime gifts. That exemption is $11.2 million. With a provision called ‘portability’, a married couple can exempt $22.4 million in lifetime gifts and bequests.
Example: From the example above, Lucy files form 709 and opts to count the $20,000 gift to her son against her lifetime $11.2 million exemption. As a result, no taxes are due, but her lifetime remaining exemption now goes to $11.18 million. Any amount over this amount gifted during lifetime or bequeathed at death, will be subject to taxation.
With those kinds of numbers, most people don’t have to worry about paying gift taxes, even if they give otherwise taxable gifts. But, what’s important is that they comply with filing the gift tax return in any case where there is a taxable gift. This will help to keep a paper trail and help with the eventual ‘final accounting’ at their death.
Birthdays and holidays, meanwhile, can continue to be joyous events.