Recently we spoke to a client who would like to help her daughter out with a down payment for a new home. When the words “Gift Tax” came up in the conversation, you could hear the fear of more taxation in her voice. No need to fear. Let us clarify what that really means.

What is a Gift Tax?

The 2020 annual gift tax limit is $15,000 per person or $30,000 per married couple. What do these limits mean? A person can give away $15,000 to anyone and to as many people as they would like without having to file IRS form 709 with their taxes.

A gift tax was created to prevent wealthy people from giving away large amounts of money to avoid estate taxes at death. Gifting, however, is still a great way to reduce your estate tax limit if you happen to have that much money. The 2020 federal estate limit before incurring taxes is $11.58 million per person or $23.16 million per married couple. It is also important to note that married couples can share this estate limit. When one partner dies, the other partner may have their $11.58 million plus whatever the other partner did not fully use.

What is a Gift?

To understand the general premise of the gift tax there is another important piece of the puzzle. Understanding how the IRS defines a gift. A gift is anytime there is a transfer of cash or property without receiving something of equal or fair market value in return. Many of us give gifts to friends, family, co-workers, and staff. But we do not generally buy gifts that cost more than $15,000. The gift limit generally applies toward family members. If Maureen gives her son Robert a home that is worth $200,000, then she has given him a gift of $200,000.

While this scenario is unlikely, it is becoming more common for parents to help children with affording homes. Here is another scenario in which the gift tax matters: If Maureen sells Robert a home for $50,000, but it is worth $200,000, then Maureen gave Robert a gift of $150,000. Another gift scenario that many folks may not be aware of are loans to friends and family that are interest free or below the IRS Applicable Federal Rate. The IRS views these as gifts, not loans. So, if you would like to loan money to a friend or family member, you must charge them a minimum amount of interest and report it on your taxes.

Married Couples and the Gift Tax

Another tax advantage to being married is the ability to give unlimited gifts to your spouse. This only applies if your spouse is a U.S. citizen. If your spouse is not a U.S. citizen, then you are limited to giving them $157,000 a year (in 2020).

Gift limits are more specific when one or both spouses give a gift to someone else. The $30,000 per married couple gift limit comes into play when the gift comes from one spouse’s bank account but is from the couple. For example, Wendy and Stan are married. Wendy gives $20,000 to her daughter Emma. $20,000 is over the $15,000 gift limit for an individual. So that would be an issue. However, since Wendy is married, the gift can be from the couple and falls within the $30,000 limit. You are supposed to file this “split gift” on IRS Form 709.

Notable Exceptions to the Gift Tax

There are exceptions to the gift tax limit. They are the following:

• Gifts to non-profit organizations
• Gifts to political organizations
• Tuition
• Direct payments for medical care

Children and the Gift Tax Limit

The gift limit restrictions also affect contributions to a 529 plan to pay for college. One exception to the annual limit is the ability to frontload your child’s 529 with 5 years’ worth of contributions. This means you can contribute $75,000 (5 x $15,000) or $150,000 if married (5 x $30,000) at once. You will not be able to contribute again for 5 years.  This means you have used up the gift limit for all gifts, such as funding an ESA, UTMA, etc.

What Does This All Mean?

Very few people will ever need to worry about paying a gift tax. Even when you go over an annual limit and file IRS Form 709, all you are doing is reducing your federal estate limit by the amount you over-gifted. In other words, a gift tax is not calculated until you die. And at that point, does it really matter?