Definition
Gift tax is a federal tax applied to an individual giving anything of value to another person. It’s applied for gifts over a certain value, beyond which the giver is taxed. However, there’s an annual gift tax exclusion limit, under which no tax is required.
Phonetic
The phonetics of the keyword “Gift Tax” is /ɡɪft tæks/.
Key Takeaways
Three Main Takeaways About Gift Tax
- Gift tax applies to the giver, not the receiver: The person who gives the gift is typically responsible for paying the gift tax.
- Annual and lifetime exclusions: In 2022, the annual gift tax exclusion is $16,000 and the lifetime exemption is $12.06 million. Gifts that are under these amounts typically do not incur gift tax.
- Some gifts are tax exempt: Certain gifts, such as ones towards tuition or medical expenses, are often not subject to gift tax. Similarly, gifts between spouses and gifts to political organizations for their use are generally tax free.
Importance
The Gift Tax is an important aspect of business and finance because it concerns the transfer of wealth. According to the U.S. Internal Revenue Service, a gift tax is a federal tax applied to an individual giving anything of value to another person. Such gifts, if they exceed the annual exclusion limit, could be subject to the gift tax. Understanding the gift tax can play a crucial role in estate planning, potentially informing decisions about when and how much to gift during a person’s lifetime to reduce the size of their taxable estate upon death. Moreover, this knowledge can help individuals avoid any unintended tax consequences of generous giving. Hence, the gift tax is a significant component in personal finance, wealth management, and tax planning strategies.
Explanation
The purpose of the gift tax is primarily to stop individuals from avoiding the estate tax by giving away their money before they die. The estate tax applies to property transferred at death and the gift tax applies to transfers made while a person is alive. By using these two taxes together, the Internal Revenue Service aims to prevent people from simply handing off portions of their estate, before they die, in an effort to avoid the estate tax.The gift tax is used to ensure that if you give someone money or property during your life, you pay taxes on the gift. The donor is generally responsible for paying the tax. This discourages individuals from circumventing limits on tax-free transfers of wealth and ensures tax is paid on the transfer. It is worth noting that the IRS allows individuals to give away a certain amount each year (for 2022, it’s $16,000) to as many people as desired without incurring a gift tax; this limit is known as the annual exclusion. Also, gifts to spouses, donations to charities, and payments for someone else’s tuition or medical bills are typically exempt from the gift tax.
Examples
1. Real Estate Gifts: Suppose Mr. Smith, a wealthy businessman, decides to gift his daughter a house worth $700,000. In the US, as of 2021, the gift tax exclusion limit is $15,000 per recipient per year. This means he can gift his daughter $15,000 worth of property without incurring gift tax. Anything over this amount falls under the gift tax category. However, there is a lifetime exemption limit of $11.7 million, so even if the house is worth more than $15,000, Mr. Smith won’t have to pay gift tax unless his total gifts throughout his life exceed this limit.2. Financial Gifts: If both of Mrs. Thompson’s parents transfer $20,000 into her bank account for her wedding, each parent will have gifted $5,000 ($20,000 – $15,000) that’s taxable for that year. However, if each parent’s total gifts to Mrs. Thompson or anyone else never exceed their lifetime exemption, they won’t actually have to pay any gift tax.3. Stock Gifts: Mr. Johnson gives his niece 100 shares of a company, with each share being worth $200. The total gift value comes to $20,000. Since this is above the annual exclusion limit, the $5,000 ($20,000 – $15,000) amount will be considered for the gift tax. But, just like in the previous examples, unless Mr. Johnson surpasses his lifetime exemption with other gifts, he does not have to pay gift tax.
Frequently Asked Questions(FAQ)
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 donor but in some cases, could be borne by the recipient.
Who is liable to pay the gift tax?
The donor, or the person giving the gift, is primarily responsible for paying the gift tax.
Are all gifts taxable?
No, not all gifts are taxable. There are certain amounts that are exempt from gift tax, including annual exclusions, which are adjusted yearly for inflation, and lifetime exemption amounts.
What is the annual gift tax exclusion?
The annual gift tax exclusion is a certain amount that one person may gift to another in a single year without incurring a gift tax. For 2021, the annual exclusion is $15,000 per person.
Can I deduct gift tax from my income tax?
No, gift tax cannot be deducted from income tax. It is a separate entity and doesn’t have any effect on income tax.
Are there exceptions to the gift tax law?
Yes, there are numerous exceptions. Payments made directly to educational institutions for tuition, medical payments made directly to health facilities, gifts to your spouse (if they are a U.S. citizen), and donations to political organizations, for instance, are typically exempt from the gift tax.
How is the gift tax reported?
If your gift exceeds the annual exclusion and isn’t apart of the exceptions list, you will need to file IRS form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Are gifts from a foreign person subject to gift tax?
Gifts from foreign individuals or estates may not be subject to U.S gift tax, but the recipient may need to report these gifts if their total value exceeds a certain amount in a year.
Are gifts to spouses tax-exempt?
Yes, one spouse can give unlimited gifts to the other spouse without being subject to gift tax, provided that the spouse is a U.S. citizen. For non U.S. citizen spouses, there is a limit to the gift’s value.
: Does gift tax affect the lifetime estate tax exemption?
: Yes, it does. The gift tax and estate tax share a lifetime exemption. The amount given over the annual exclusion reduces the lifetime exemption amount for the estate tax.
Related Finance Terms
- Tax Exemption
- Annual Exclusion
- Gift Tax Return
- Lifetime Exemption
- Unified Credit
Sources for More Information
