Jane writes in to ask,
“I’m considering giving a large-ish gift to my son to help him purchase his first home. I think I understand that he won’t have to pay any tax on this gift, but I might have to. Is that correct? And how do I know if I have to pay any tax?”
Will the Recipient Have to Pay Any Tax?
The recipient of a gift does not pay any tax on that gift. Gifts are not included in taxable income, and the gift tax only applies to the person giving the gift, not to the person receiving it.
Will the Giver Have to Pay Any Tax?
The person giving the gift is subject to the gift tax, but, for a few reasons, there won’t actually be any tax owed in most cases.
First, none of the following types of transfers will result in taxable gifts:
- Gifts to your spouse,
- Gifts to a qualifying charity,
- Gifts to a political organization for its use, and
- Payments made directly to an educational institution or health care provider for somebody else’s tuition or medical expenses.
And for gifts that don’t fall under any of those exclusions, you can still give up to $13,000 per year to each recipient without the gift being taxable. (If you’re married filing jointly, you and your spouse can give a total of $26,000 per year to each recipient.)
In addition, even if you pass that $13,000 annual exclusion amount, you still have a long way to go before you actually have to pay any taxes. That’s because you also have a “unified credit” that exempts the first $5,000,000 of otherwise-taxable transfers that you make.
I say “transfers” rather than “gifts” because this credit is also the one that exempts your estate from estate tax when you die. So the more of it you use by giving gifts during your lifetime, the less of it you’ll have available to offset estate taxes for the benefit of your heirs. Still, for most people, $5,000,000 is plenty–more than enough to offset all the gifts they make during their lifetime as well as their entire estate.
Important note #1: Like tax brackets and many other aspects of our tax code, this $5,000,000 figure is something of a political football. It gets kicked around from year to year, so there’s no guarantee that it’ll still be set at $5,000,000–rather than at some lower number–at any particular point in the future.
Important note #2: If you exceed the annual $13,000 exclusion in any year, you do have to file a gift tax return (Form 709), even if you don’t have to pay any tax.
If you do end up exhausting your entire unified credit, the tax rates on the taxable amount of your transfer can be found in the instructions to Form 709.
How about an Example?
Raymond is an unmarried taxpayer. He’s never made any taxable gifts before. In 2011, he makes the following gifts:
- $80,000 to the American Red Cross,
- $10,000 to his nephew, and
- $20,000 to his niece.
How much gift tax will Raymond have to pay? Zero.
- Raymond’s gift to the Red Cross isn’t taxable because it’s a gift to a qualifying charitable organization.
- Raymond’s gift to his nephew isn’t taxable because it’s less than the $13,000 annual per-recipient exclusion amount.
- $7,000 (that is, $20,000 — $13,000 annual exclusion) of Raymond’s gift to his niece will be taxable. But Raymond will not have to pay any gift tax because of his $5,000,000 lifetime exclusion amount. After this year, his remaining exclusion amount will be $4,993,000 (or $5,000,000 — $7,000).
Note, however, that Raymond will have to file a gift tax return for the year because the gift to his niece exceeded the annual $13,000 exclusion.
Generation-Skipping Transfer Tax
If you make a gift to somebody two or more generations below you (e.g., your grandchild), the transfer could be subject to the generation-skipping transfer tax, which is a separate tax in addition to the gift tax. But, like the gift tax, it comes with a large lifetime exemption (currently $5,000,000) that you’d have to exhaust before owing any actual tax.