It always feels good to hook your friends and family up with gifts, but gifters beware. There are limits on how nice you can be before taxes become a factor. And it matters because federal gift tax rates ain’t no joke. They can reach as high as 40%. Connecticut is the only state that charges, so it’s basically a federal tax issue.
So what is a gift? A broad definition is giving something to someone without expecting anything in return. A more specific definition is your presence in the world, but that’s for another day. Examples of gifts include cash, jewelry, stocks and numerous other assets. Some gifts are not so obvious like providing a family member with an interest free loan or selling a speedboat to a friend for $1. Situations like these may be reportable and possibly even taxable. Reportable means you must tell the IRS about it but might not have to pay taxes.
Let’s take a look at the specific rules related to reporting and taxing gifts. First off it is important to note that the person giving the gift is also the one that reports and pays taxes on the transaction. The person receiving doesn’t have to do anything. In 2020 an individual taxpayer is allowed to gift $15,000 to as many different people as they want and no reporting or tax is involved. Once the $15,000 threshold is crossed, reporting and paying comes into play. Just to be clear you are safe as long as each gift you give is not worth more than $15,000. You can buy a box of $15,000 watches, stand on the street corner and hand them out to strangers until the box is empty and you won’t report anything or pay any taxes. If instead you opted for the signature edition watch that costs $15,001 then you are in a reportable situation.
The situation is reportable but may not be taxable. It depends if the taxpayer has used up their lifetime gift exclusion. Individual taxpayers have a lifetime limit of $11.58 million per taxpayer for the 2020 tax year. Congress changes this number all the time. In 2003 it was one million dollars and in 2012 it was five million, but based on current law, you can give away $11.58 million worth of assets over your entire lifetime and no taxes will be paid on any of the transactions. The gifts are reportable but there will not be any taxes due. This is where the $15,000 per gift comes into play. In our watch example above the $15,000 watches do not go towards the $11.58 million lifetime exclusion so you could give away billions of dollars worth of $15,000 watches and never have to report or pay anything. The $15,001 watches are different because you must report this transaction and the extra dollar per watch goes towards the $11.58 mil lifetime exclusion. Once all those extra dollars add up to more than $11.58 million, gift taxes come into play where rates go as high as 40%.
An individual can accept an unlimited amount of gifts from as many people they want and never have to pay any tax. However taxes do become a factor if the recipient sells the gift. Taxes may be due if the gift is sold for more than its basis, which is typically the value on the date of transfer. A good example is someone receives 100 shares of stock in Bank of America on a day it is trading at $25 per share. This gift is worth $2,500 on the date of transfer (100 shares x $25 per share), so if the recipient later sells the shares for more than $25 each, the taxpayer has a capital gain. If the sales price is less than $25 the taxpayer has a capital loss. Either way when you sell something that someone gave to you as a gift, there are probably going to be tax implications.
So what is not a gift? The IRS makes it very clear the following situations are not gifts. This is not an all-inclusive list:
- Asset transfers between spouses as long as both are US citizens
- Asset transfers to certain charitable organizations
- Paying for someone else’s medical bills
- Paying for someone else’s tuition bills
- Providing food, clothing and shelter to a dependent
Gifts can have unintended consequences to the giver and the receiver so be careful when helping others. If you give someone a gift make sure they know their side of the reporting requirements. Reportable gift transactions require an annual gift tax return (Form 709) and other forms depending on the specific transactions involved. Contact our office today for assistance with this and other forms.
Joe Wright CPA PLLC provides the information in this blog as a general guide. Tax laws are extremely complex, and every taxpayer is unique. Some or all of this information may or may not apply to you. We provide simplified situations to clarify some of the major aspects and highlights of the topic at hand. Some of the language used is casual and may be misconstrued. Please make an appointment with us soon to discuss your particular circumstances.