Gift Tax 101

We are going to provide an explanation of the gift tax in this post, but before you can understand the purpose of this tax, you have to digest some information about the federal estate tax.

This tax can significantly erode the wealth that you would like to pass along to your loved ones, because it carries a 40 percent top rate. Fortunately, most people don’t have to pay the tax because there is a credit or exclusion that you can use to transfer a certain amount tax-free.

During the current calendar year, the exact amount of this exclusion is $11.58 million. It is updated annually to account for inflation, so you will see a somewhat higher figure next year.

It should be noted that the estate tax is not applicable on transfers to your spouse if you are married to an American citizen.

Federal Gift Tax

When you hear about the existence of the estate tax, it would be logical to think about giving gifts while you are living to avoid the tax. This is a move that people used to make shortly after the estate tax was originally enacted in 1916. In 1924, a gift tax was put into place to close this window of opportunity.

There was resistance from some legislators, and it was repealed in 1926. Once again, wealthy people could give gifts while they were living, but the gift tax was reenacted in 1932. It has been in place continuously ever since then.

The $11.58 million exclusion that we have this year is a unified exclusion. It applies to large lifetime gifts along with the value of the estate that will be transferred to your heirs after you are gone.

Annual Gift Tax Exclusion

In addition to this unified lifetime exclusion, there are a few other exclusions that you can use to transfer assets in a tax-free manner. One of them is the annual per person gift tax exclusion.

You can use this exclusion to give as much $15,000 to any number of people each year free of taxation. This is another figure that is updated from time to time, so it may change at some point in the future.

If you are exposed to the federal estate tax, you could use this exclusion to transfer assets tax-free before you pass away. Granted, you would be limited. However, if you take the right steps for an extended period of time, you can make good use of this exclusion.

Since it is allotted to each individual taxpayer, so you and your spouse can each give $15,000 to an unlimited number of gift recipients annually.

To provide an example of how this exclusion can be used effectively, let’s say that you have four married children. You and your spouse could combine your exclusions to give $30,000 every year to each husband and each wife.

That would be $60,000 a couple, and when multiply that by four, you are looking at $240,000. In 10 years, $2.4 million of the family wealth would be transferred tax-free. In addition to direct gift giving, this exclusion is often used to fund certain types of tax efficiency trusts.

Educational Exemption

Under the tax code, you can pay school tuition for any number of students, and the gift tax would not be a factor. There is no limit to the overall amount that you can spend on tuition, but you have to pay the institution directly. This exemption does not extend to books, fees and living expenses, but you could use your annual $15,000 exclusion to provide additional support.

Medical Exemption

You are allowed to pay medical bills for others without being taxed for your generosity. This medical exclusion extends to the payment of health insurance premiums for other people.

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