It would be logical to assume that you could give a gift without any tax consequences. Imagine this simple scenario. You receive your salary via direct deposit, and you notice that about 40 percent of your pay has been absorbed by taxes. It is your son’s birthday, and you take some of the remainder to buy him a gift. You pay sales tax on the gift.
That is a lot of taxation when you put it all together. However, technically speaking, the gift is also taxable.
There is a gift tax in place in the United States, and it carries a 40 percent maximum rate. It was enacted to stop people from giving gifts in an effort to avoid the estate tax, which also carries a 40 percent top rate.
The reason why you are probably not evading taxes when you do not pay the gift tax on gifts that you give to your loved ones is because there are a number of different exclusions. We will look at the gift tax exclusions in this post.
Inheritance Tax Misconception
We should point out the fact that many people assume that the terms “inheritance tax” and “estate tax” are interchangeable ways of describing the same tax. In fact, this is not the case. An inheritance tax could be levied multiple times when one estate is being administered. This type of tax is applied on transfers to each nonexempt inheritor. An estate tax is levied on the entire portion of an estate that is taxable before it is distributed among the heirs. There is no federal inheritance tax, and though there are a handful of states that have inheritance taxes, Indiana is not one of them.
Marital Deduction
There is an unlimited marital gift and estate tax deduction. If you are legally married in the eyes of the law, you can transfer unlimited assets to your spouse free of the gift tax. You can also leave unlimited assets to your spouse after you pass away without incurring any death tax exposure.
Annual Per Person Exclusion
The first gift tax exclusion that we will examine is the annual per person gift tax exclusion. This allows you to give up to $14,000 in gifts to any number of individual gift recipients within a calendar year free of the gift tax.
This $14,000 figure is in place during 2017, which is when this is being written. There are periodic adjustments to account for inflation, so the figure may rise a bit in the future.
Unified Gift and Estate Tax Exclusion
In addition to the $14,000 per year, per person gift tax exclusion, there is also a unified lifetime gift and estate tax exclusion.
As we mentioned previously, the gift tax exists to prevent people from giving gifts in an effort to avoid the estate tax, and the two taxes are unified under the tax code. The unified gift and estate tax exclusion is $5.49 million in 2017.
You could use some of your unified exclusion to give tax-free gifts to people within a calendar year that exceed $14,000 per person. However, as you are giving these gifts, you would be reducing the amount of the unified exclusion that would remain to be applied to your estate and future tax-free lifetime gifts.
School Tuition Exclusion
Another exclusion that you could utilize to give tax-free gifts is the educational exclusion. You are allowed to pay school tuition for students without incurring any gift tax liability, but you have to pay the schools directly. Plus, this exclusion does not include books and fees. Living expenses, like dorm fees and meal programs would not be included either. You could however use your $14,000 per person annual exclusion to provide additional resources tax-free.
Plus, there is another consideration. If you are married, you can give $14,000 to any number of people tax-free within a calendar year, and your spouse can do the same. Let’s say that you want to pay your grandson’s way through college. You and your spouse could combine your respective exclusions and provide up to $28,000 for additional expenses each year in a tax-free manner.
Health Care Exclusion
The final exclusion that we will touch upon here is the health care exclusion. If you choose to pay medical bills for others, you would not be taxed for your generosity. In addition to medical bill payments, you can also provide health insurance for other people free of the gift tax.
Once again, you would have to pay the health care provider or insurance company directly.
Learn More
If you would like to learn more about taxation and other important estate planning topics, visit our seminar page to register for the free local session that fits into your schedule.
Paul A. Kraft, Estate Planning Attorney
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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