December 4, 2011

How Do Gift Taxes Work?

Have you ever worried that if you give someone a large gift like a car or a house or a large pile of money that you or the recipient would have to pay gift taxes?   You may have heard that there is a $13,000 gift tax exemption.   That is good for gifts of less than $13,000 in value but then do you owe gift taxes for gifts of more than $13,000?

I'm going to make a broad generalization and say that you don't need to worry about gift taxes.    Read on and I'll explain why I say this.   There are exceptions to this generalization but for 99% of us the gift tax is a non issue. And if you do have to pay gift tax when filing your tax return, there are free tax prep programs that will make it easier.

First we have to understand what gift taxes are and how they really work.

Why do we have gift taxes?
Gift taxes are basically a way for the government to keep people from avoiding estate taxes by giving away all or most of their money before they die..   Before gift taxes existed someone with a very large estate could give away millions of dollars and then avoid most of the impact of estate taxes.  If they give their money away before their death then theres nothing left to pay estate taxes on.   Gift tax was then developed as a way to counter that tactic.

How do Gift Taxes work?

You can read all about gift taxes in the IRS Publication 950 Introduction to Estate and Gift Taxes

I'll summarize the very basics.   If you give someone a large gift then you have to file a form with the IRS to record it.   You subtract the $13,000 annual exclusion from the gift then figure the amount of gift tax on the gift.  The amount of the gift tax is then deducted from your unified credit which would apply to estate taxes.   Once your exemption is used up then you will owe tax on that gift.   The unified credit is $345,800 and that will eat up a lot of gift tax.  You do not have to pay any tax out of pocket as long as you have some of that credit left.   So you can give away gifts an incur gift taxes up to $345,800 before a single dime comes out of your own pocket towards gift tax.

Therefore...

Only Millionaires actually pay Gift Taxes.   Let me repeat that... only millionaires pay gift taxes.


Now if you are a millionaire and have a large estate then you do have to be careful about gift taxes.   This is the key exception to the generalization I made before.   A few people (millionaires) do have to pay gift taxes.   However with some careful planning most millionaires can avoid gift taxes as well.

Who pays gift tax?

The giver of the gift is the only person who may be responsible for the gift tax.  People receiving gifts do not pay and don't need to worry about gift taxes.

What do Gift taxes apply to?

Its not as if any or every kind of gift can cause a gift tax.    Many gifts are exempt from gift taxes:


  • Gifts, excluding gifts of future interests, that are not more than the annual exclusion for the calendar year,
  • Tuition or medical expenses you pay directly to a medical or educational institution for someone,
  • Gifts to your spouse,
  • Gifts to a political organization for its use, and
  • Gifts to charities.

Bottom Line :   Gift taxes won't impact the vast majority of people and are generally not anything to worry about. 
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1 comment:

  1. We don't have a gift tax in Canada but we do have to pay tax if giving away a property or investment. I don't think we have an estate tax either up here, but we have something else in its place. Sometimes we just call things differently. Our finance minister introduced the TFSA a few years ago. Claimed it was the best savings vehicle for Canadians since 1957, and received positive recognition. But you guys have been using the Roth IRA for years already, which is essentially the same thing, same contribution limit even.

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