Much like estate tax, the gift tax is an issue of financial concern for individuals interested in giving part of what they own to another individual, such as a family member or close friend. However, unlike estate taxes, gift taxes specifically apply to assets that are given to another person during one’s lifetime. In essence, the gift tax keeps individuals from avoiding the estate tax by passing on assets or goods prior to death; it ensures that gifts are taxed at the same rate regardless of when they are passed to another individual.
The Limited Applicability of the Gift Tax
In reality, the gift tax is an issue of concern for only a very small segment of the population. This is because it only applies when an individual gives away more than approximately $5.43 million to another person. This amount is adjusted slightly for inflation each year. Thus, if you give your children a rare piece of art worth several thousand dollars, or even a home worth one million dollars, these gifts will not be subjected to the gift tax because they fall below the monetary threshold. Making the applicability of the gift tax even more rare, it does not apply to gifts left to certain individuals—most importantly, your spouse. So any individual is free to “gift” as much as they would like to their husband or wife. Because of these limitations, it is unlikely that many reading this article will find themselves concerned about the gift tax in the near future. However, it is important to understand how these types of taxes work, in case they do become an issue at some point.
Understanding How the Gift Tax Is Applied
The gift tax applies to any asset or item that is transferred to another individual either for free, or for a below-market value. The fair market value for an item is determined by calculating what the average person would pay for the property or good offered. Thus, if your house would reasonably sell for around $350,000 according to a realtor or home-buying website, this is likely the fair market value. If you give that house to a child for free, or offer to sell it to them for far below that amount, such as for $30,000, these are both gifts and, if your total amount of gifts meets the monetary threshold discussed above, the gift tax would apply. It is important to note that the gift tax is applied against the individual who is giving the gift, not the individual who is receiving it. If you owe a gift tax, you will be required to file a special gift tax return in order to pay that tax. Currently, gifts are taxed at a rate of 40 percent.
Certain items are exempt from the gift tax requirement. These include, payment of medical expenses, payment of tuition, donations to charities, donations to political organizations, and, as mentioned above, gifts to a spouse.
If you are considering making a very large gift to a family member or friend, you may wish to discuss with an estate and trusts attorney, or an accountant, about how the gift tax may apply to you.