It’s income tax time again, so taxes are on everyone’s mind. As an elder law attorney, the one question or comment that I hear the most has to do with gift taxes. The federal gift tax engenders more misconceptions than any other issue of which I am presented.
Notice that I say federal gift tax. There is no state gift tax of which I am aware. Certainly, New Jersey does not impose a gift tax. To my knowledge, only the federal government imposes a gift tax.
Most people who mention gift tax to me believe that there is some amount of money that they can gift in any one year without triggering a gift tax–$10,000, $11,000, $14,000. People get those figures from a concept known as the annual gift tax exclusion.
The annual gift tax exclusion amount is indexed for inflation. When I first started practicing, the annual gift tax exclusion was $10,000. The amount—indexed for inflation—has increased to its current level of $14,000.
Most people tend to believe that if they gift more than $14,000 in any one year, they—or the recipient of the gift—will pay a tax, a gift tax. But knowing the annual exclusion amount is really only part of the story, the small part actually.
The full rule would be as follows: A person can gift the annual exclusion amount (currently $14,000) every year to an unlimited number of people without reducing his lifetime exclusion against gift tax. It is the lifetime exclusion amount that makes gift tax irrelevant for almost all taxpayers.
A person’s lifetime exclusion amount is currently $5,490,000, a figure that is also indexed for inflation. So, putting it altogether, a person can gift $14,000 a year to an unlimited number of people without reducing his $5,490,000 lifetime exclusion against gift tax.
In short, unless you have more than $5,490,000 in assets—and very few people do—you do not have to worry about gift tax. A married couple can essentially double these credit amounts. A married couple could gift $28,000 a year to an unlimited number of people without reducing their $10,980,000 lifetime credit against gift tax. Very, very few people have that much money.
What then is this $14,000 all about? Assume that Mr. Smith gifted $14,000 in a given year to 200 of his closest friends. Assume further that Mr. Smith gifted $15,000 to one of his friends—perhaps just to show he liked him a bit more than the others. Since Mr. Smith gifted $1,000 more than $14,000 to one person, Mr. Smith’s lifetime exclusion amount of $5,490,000 would be reduced to $5,489,000.
If Mr. Smith did, over the course of his lifetime, gift more than $5,490,000 taking into consideration his $14,000 annual exclusion amounts, then Mr. Smith, not the recipient of the gift(s), would pay gift tax. A gift tax return—which is separate and apart from an income tax return—must be filed if Mr. Smith gifts more than $14,000 in any given year; however, unless he exceeds the lifetime credit amount, then there is no gift tax owed.
The recipient of a gift never pays gift tax. The receipt of a gift is tax-free.
Now, there is another issue with gifting assts. If Mr. Smith gifts his son stock that Mr. Smith has owned for years, then Mr. Smith’s son will receive Mr. Smith’s basis in the stock. This means that if Mr. Smith purchased the stock for $1.00 and the stock is worth $10.00 today, then the son will have a basis of $1.00. When the son sells the stock, the son will have to pay income tax on the $9.00 of gain.
If Mr. Smith died owning the stock, then the son would have received a basis step-up, meaning that the son’s basis in the stock would step up to $10.00. When the son sells the stock, the son would not realize any gain and would not have to pay income tax on the sale of the stock.
Gift tax rules are often misunderstood because the annual exclusion is only one part of a much larger system. Understanding how lifetime exemptions, gift tax reporting, and basis rules work together can help families make informed estate planning decisions and avoid costly misconceptions about gifting assets.