Gift tax

What is the federal gift tax?

The federal gift tax applies to assets transferred to a beneficiary during the donor’s lifetime. This is in contrast to the estate tax, which applies after the donor’s death. The gift tax is paid by the donor; the beneficiary does not pay gift taxes, although income taxes may apply.

How does the tax work?

Any gift is considered taxable, but current law provides for some exceptions. The annual exclusion limit in 2015 is $14,000. If total value of the gifts you transfer to any one beneficiary in a year are at or below the limit, the tax does not apply.

The limit applies to each donor and each beneficiary. So you can give gifts to multiple beneficiaries without gift taxes as long as each gift doesn’t exceed the yearly limit. The limit applies separately to a husband and wife, so in 2015 they could give a combined $28,000 to a beneficiary without a gift tax. Incidentally, gifts made to your spouse who is a U.S. citizen are not subject to the gift tax.

Another common exception to the gift tax is gifts made to educational institutions and medical providers on behalf of a beneficiary. So tuition payments made directly to your child’s college or payments to your relative’s doctor for diagnosis and treatment are not subject to the gift tax or the yearly limit.

There’s also a relationship between the gift tax and estate tax. Both apply to the total lifetime gift exclusion, which in 2015 was $5.43 million. You can transfer up to $14,000 per year to each of your beneficiaries during your lifetime in order to reduce your estate, but these gifts would also apply to the lifetime gift limit.

For example, if the total amount of gifts you had made during your lifetime was $1 million, then the most you could transfer in your estate would be $4.43 million in order to avoid the estate tax. Yes, the IRS expects you (or your accountant) to keep track of gifts you make for this purpose. The federal gift tax exists for this very reason – to prevent people from circumventing the estate tax by transferring their assets to their beneficiaries while they are alive.

There are other exceptions to the gift tax. Payments for medical insurance on behalf of a beneficiary are not considered gifts. Neither is adding a beneficiary as a joint tenant on a bank or brokerage account. Gifts to legal minors are also not taxable. So if you gave $20,000 to your 16 year old son, this would not be taxable as it is considered part of your support.

There are different rules for valuing assets between gift taxes and estate taxes. If you transfer stock or real estate to your child through your estate, your child’s tax basis of the property is the market value at the time of your death. But if you transfer the asset while you’re alive, the tax basis is the same as yours, whatever you originally paid for it. This difference allows beneficiaries to save billions of dollars in taxes every year.

For more information

For more information about the federal gift tax, see this article and the IRS’s gift tax page.