GIVING YOUR MONEY AWAY
Don’t Let Gift Tax Stop You
Few concepts are more misunderstood than the taxation of gifts. Some people believe that any gift of significant value is subject to tax. Others believe that a gift increases the recipient’s income. The truth is, in most cases, a gift causes no tax consequences.
While the general rule is gifts are subject to tax, there are so many exceptions to this rule that by far, most gifts aren’t taxed. For instance, everyone receives a credit against gift tax equivalent to $675,000. So, you would have to give away more than $675,000 before paying gift tax. Furthermore, the credit is scheduled to rise to $1,000,000 by the year 2006. So, by 2006, you will have to give away more than $1,000,000 before paying gift tax .
If that weren’t enough, there is an unlimited deduction for gifts between spouses, charitable gifts, and for payments made for someone else’s medical bills or tuition.
Lastly, there is the $10,000 annual exclusion. The $10,000 annual exclusion means that you can give up to $10,000 a year to an unlimited number of donees without paying gift tax and without reducing your $675,000 credit. For example, you could give $10,000 to 50 people, reducing your estate by $500,000, without eating into your $675,000 credit. And, you could do that year, after year, after year.
As the donor, you would pay no gift tax, and the donee would also pay no gift tax and no income tax. As an aside, it is the person making the gift, called the “donor,” who would pay the gift tax, if any, not the person receiving the gift, called the “donee.”
If the gifted asset earned income before the gift was made, for example, if you gifted $10,000 in stock and the stock paid dividends prior to the date of the gift, the donor would claim the dividends on his income tax return. If the stock earned dividends after the gift was made, the donee would pay income tax on those dividends. But the gift, the $10,000 in stock, is not subject to income tax.
If a donee gifts more than $10,000 to any one person in any year, then that part of the gift that exceeds $10,000 reduces the donor’s $675,000 credit by that part of the gift that exceeds $10,000. For instance, if a father gifts $110,000 to his son, the first $10,000 is treated as the $10,000 annual exclusion; the remaining $100,000 reduces the father’s $675,000 credit to $575,000. No gift tax is due.
It is only if a person reduces their credit to zero that they would, potentially, have to begin paying gift tax. Gift tax would only be owed on future gifts if those gifts did not qualify for one of the many exceptions to the general rule, e.g., the $10,000 annual exclusion, unlimited marital deduction, charitable deduction, medical bills or tuition.
A person would have to give away a lot of money before they began paying gift tax. Most people don’t own assets worth more than $675,000. They could give away every penny they have and would never be subject to gift tax. They are in no way limited to giving away only $10,000 a year.
I have met so many people who wish to give money to relatives for one reason or the other, but believe they are only able to give $10,000 a year. Many of these individuals have a net worth less than $400,000.
Though I would advise against giving away all of your money – unless done for a distinct purposes, such as Medicaid planning – a person who is worth $400,000 or less could give away all of their money without paying any gift tax. They would have to file a gift tax return with the IRS, but there would be no tax owed.