Presents! Fun to give, fun to get, but what about taxes? Since we are smack-dab in the middle of gift-giving season it seems like a good time for a primer on the tax consequences of making and receiving gifts. Here are a few things to keep in mind.
A Gift is not taxable income to the recipient. Gifts are essentially free money to the recipient. If my dad gives me $10,000 this is not income to me – I do not have to report it on my income tax return.
A Gift to an individual is not income tax deductible by the gift giver but a gift to a qualified charity is. When my dad gives me that $10,000 he cannot deduct that on his income tax return. However, if he gave that money to the American Cancer Society instead of to me, it would be deductible on his income tax return. Gifts to so-called qualified charities are deductible up to 50% percent of a taxpayer’s adjusted gross income. A 30% limitation applies to contributions to private foundation. The IRS publishes a booklet which explains the rules for deductibility of charitable gifts in detail.
Most people don’t need to worry about gift tax. The gift tax seems to be the most misunderstood tax in the tax code. First of all, the gift tax is a federal tax only (except if you live in Connecticut). The key aspects of the federal gift tax are:
- In 2016 each person may give $5,450,000 during their lifetime before there is any gift tax payable ($5,490,000 in 2017). This amount is sometimes called the “lifetime credit” or “lifetime exemption”. So if you do not make gifts in excess of $5,450,000 (twice that amount if you are married), you need not worry about the gift tax.
- In addition to the lifetime exemption amount, each person may make annual gifts of up to $14,000 to as many people as they wish. This is called the annual exclusion amount. For example, if Mr. Trump gives his daughter Ivanka a business worth $5,450,000 this year, he may also give all of his children, including Ivanka, an additional $14,000 in 2016 and there would not be any gift tax due.
- If a person does give more than the allowable exemption amount, then the gift giver (not the recipient) will owe federal gift tax on the amount in excess of the lifetime credit amount at the rate of 40% (ouch!). So if the value of the business given to Ivanka is $6,450,000 then Mr. Trump will owe gift tax of $400,000 (40% of $1 million).
- A person may make unlimited gifts to a U.S. citizen spouse and there is no gift tax payable. For example, if one spouse gives the other a big office building worth $100 million, there is no gift tax payable. But, if the spouse receiving the gift is not a U.S. citizen then the amount of the gift is limited to $148,000 in 2016 (increasing to $149,000 in 2017), and there would be gift tax due on the amount of the gift in excess of the allowable amount.
- The federal gift tax is linked to the federal estate tax. Current federal estate tax laws allow each person to pass on $5,450,000 (2016) at death without any federal estate tax. However, to the extent a person ‘uses up’ some or all of that lifetime credit by making taxable gifts during his or her lifetime, the gift giver reduces the amount of the credit available at his or her death. In the above example where Mr. Trump used his entire lifetime credit by giving his daughter his business, then the full value of the assets Mr. Trump owns at his death will be subject to federal estate tax at the rate of 40% (unless of course he has repealed the federal estate tax, but that’s a topic for another day).
Capital gain tax can be an unwelcome surprise for gift recipients. Most people are familiar with capital gain tax which works like this: Dad buys 100 shares of Microsoft stock for $1,000 in 2000. In 2016, that stock is now worth $10,000. If he sells the stock, he will have a gain of $9,000 ($10,000 – $1,000) on which he will have to pay capital gain tax. If Dad gives the stock to Daughter, he will have made a gift of $10,000 – the current value of the gift. As we know from above, there are no gift tax implications to either Dad or Daughter. Even though Daughter received a gift worth $10,000, her tax basis in the stock is the same as Dad’s – $1,000. That means that when Daughter sells the stock, she will have to pay capital gain tax just like Dad would have had to pay.
If instead of giving the stock to Daughter as a gift, Dad kept the stock and then Daughter inherited it when Dad passed away, Daughter’s tax basis in the stock would be the market value of the stock on the day Dad died. That means that if the stock was worth $10,000 when Dad passed away and Daughter sells it for $10,000 she will not have any capital gain ($10,000 – $10,000 = $0) and will not have to pay any tax – a sweet result.
There are no freebies when it comes to Medicaid eligibility. Medicaid is that state and federally funded program that provides funds to pay for long-term care nursing home care (and other care costs) for individuals who meet the financial eligibility requirements of the Medicaid program. In order to be eligible, a person cannot have more than $2,000 in countable assets. There is a 5-year ineligibility period if an applicant, or his/her spouse, gives away assets. Although there are exceptions to this rule, such as gifts made to a spouse or to a disabled child, there are no exceptions for the amount of a gift. The annual gift tax exclusion amount described above has no bearing on, or relation to, the Medicaid rules.
The bottom line is that while gift tax may not be an issue for most people who are considering making a large gift, there are other issues to be concerned about. Consult with your estate planning attorney so that you understand the implications and can make an informed decision before making gifts. Have a happy holiday and may you be on the receiving end of some of those gifts!