Definition
Gift tax is a federal tax applied to an individual giving anything of value to another person. It is generally paid by the donor, and is imposed on any transfer of property by one person to another without any compensation. The tax applies whether the donor intends the transfer to be a gift or not.
Key Takeaways
- Gift Tax is a federal tax applied to an individual giving anything of value to another person. It is generally paid by the giver or donor, not by the recipient.
- The tax applies whether the donor intends the transfer to be a gift or not, when the value goes beyond the annual exclusion limit set by the IRS. As of 2021, the annual exclusion limit is $15,000 per person.
- Lifetime gift tax exclusion is the total amount you can give away over your entire lifetime without paying the gift tax. This amount is $11.7 million as of 2021. Amounts given in excess of this limit would potentially be subject to gift tax.
Importance
The financial term “Gift Tax” is important because it impacts the transfer of wealth between individuals. According to U.S.
tax laws, any transfer of money or property to another person without receiving something of equivalent value in return is considered a gift and may be subject to gift tax. The donor is usually responsible for paying this tax.
Moreover, there is a specific exemption limit, and gifts below this amount don’t incur tax, which changes annually based on inflation. Gift tax laws aim to prevent people from bypassing estate tax laws by giving their wealth away before they die.
Therefore, understanding gift tax is crucial for strategic financial planning, especially for those who wish to pass a significant portion of their assets to their descendants or others.
Explanation
The primary purpose of the gift tax is to prevent the avoidance of estate tax. Essentially, the Internal Revenue Service (IRS) doesn’t want individuals to bypass the estate tax by gifting their assets before death. The estate tax applies differently, based on the value of an individual’s property and non-cash assets at the time of their death.
By imposing a gift tax, the IRS is able to still collect tax revenues from assets that are transferred before death. The gift tax applies when an individual gives another person a gift that exceeds the annual exclusion limit for that tax year. For instance, as of 2022, you can give up to $16,000 to an individual without having to pay gift tax.
If you exceed this limit, you have to pay gift tax. It is important, however, to note the gift tax is paid by the gifter, not the recipient. This tax prevents wealthy taxpayers from using gifts as a method to avoid paying estate taxes, ensuring that these assets still generate some tax revenue.
Examples of Gift Tax
Estate Gift: If an elderly parent decides to transfer their home ownership to their child, this is considered a gift and the IRS may impose a gift tax for this action. The value of the property exceeds the annual tax-free gifting limit, which as of 2021 is $15,000 per person. Therefore, a gift tax form must be filed, although the tax may not necessarily have to be paid due to the lifetime estate gift limit.
Large Monetary Gift: Let’s say a very generous aunt gives each of her three nieces $20,000 as gifts within a year. Each of those gifts exceeds the annual exclusion amount of $15,000, imposing a gift tax on the $5,000 excess for each niece. The aunt will have to report this $15,000 excess to the IRS.
Paying For Education: If a parent pays for their child’s tuition fees directly to the educational institution, this can be considered an exemption from gift tax, as payments made directly to medical providers or educational institutions on someone else’s behalf are generally excluded from gift tax. However, if they gift them money for tuition fees and do not pay directly to the institution, this could potentially be subject to gift tax if it exceeds the annual exemption limit.
Gift Tax FAQs
1. What is a Gift Tax?
A gift tax is a federal tax applied to an individual giving anything of value to another person. It is generally paid by the giver of the gift, unless arrangements are made between the giver and the receiver for the receiver to pay the tax instead.
2. Who is responsible for paying the Gift Tax?
The donor is generally responsible for paying the gift tax. Under special arrangements, the recipient may agree to pay the tax instead and it is advised to consult with a tax professional to understand the implications
3. How much can you gift before incurring the Gift Tax?
The IRS allows an annual gift tax exclusion. For 2021, the annual exclusion is $15,000 per individual recipient or $30,000 for gifts given by a married couple.
4. Are all gifts subject to the Gift Tax?
No, not all gifts are subject to this tax. Gifts to spouses, gifts to charities, directly paid tuition or medical expenses (paid for someone else) are excluded from this tax.
5. Can you deduct gifts on your income tax?
Generally, the answer is no. However, if the gift is given to a registered charity, it can be deducted from your income tax.
Related Entrepreneurship Terms
- Unified Credit
- Annual Exclusion
- Gross Gift
- Taxable Estate
- Lifetime Exemption
Sources for More Information
- Internal Revenue Service (IRS): A U.S. government agency responsible for tax collection and tax law enforcement. Detailed information about Gift Tax can be found on this official site.
- Investopedia: An immensely popular and reliable resource for personal finance and investing knowledge, including articles explaining Gift Tax.
- Nolo: A publisher of do-it-yourself legal and business books and software. Nolo’s site contains useful articles and legal advice on a wide range of topics, including Gift Tax.
- TurboTax by Intuit: A widely-used tax preparation service with detailed explanations and guides on taxes, including Gift Tax.
