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What is the Annual Gift Tax Exclusion?

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Make sure to check state-specific tax rules before acting. Many states also have estate or inheritance tax that may affect your liability.

Annual gift tax exclusion is a set amount of cash or assets that one person may gift yearly to someone without paying a gift tax. The Internal Revenue Service (IRS) implemented a gift tax code stating that over a certain limit, a taxpayer must pay taxes on gifts given. This is effective only if the donor did not receive any type of payment for the gift.  However, if the recipient received payment, the value amount must fall beneath fair market value in order for the donor to avoid paying gift taxes on their annual tax return. Fair market value is the agreed amount between the buyer and seller.  To be considered a gift tax exclusion, the gift cannot be worth more in dollars or value than the IRS code states per annual year.

The IRS set a capped dollar amount or value that annual gifts can be before being taxed. Each year the capped amount may change, due to inflation. It is vital to check the tax codes every year, to find out if the annual gift tax amount has changed.

As of 2016, you can gift up to $5.49 million during your lifetime before the IRS starts levying taxes. If you are over the lifetime limit, you can still gift up to $14,000 to as many individuals you want per year before taxes start kicking in.

For example: say you have two children and you gift each of them $20,000 and gift an additional $10,00 to another relative. The $40,000 ($20,000 to each child) would be taxable gifts for you as it exceeds the allowance of $14,000 per person, per year. However, you will not owe any taxes unless you have exceeded your lifetime allowance. If you haven’t exceeded the lifetime allowance, the two gifts will reduce your allowance by $12,000 – ($20,000 - $14,000) x 2 = $12,000. The third gift given to another relative of $10,000 will be ignored as it does not exceed the allowance for that person for the year. Basically, you can give up to $14,000 to as many people as you want and not pay tax as long as you have not exceeded the lifetime allowance.

However, if you gave monetary gifts over $14,000 each, the recipient is responsible for the tax.

Too often taxpayers confuse annual gift tax exclusions and lifetime gift exemptions. The following will help determine what gifts fall under each IRS gift tax code.

Annual gift tax exclusion

The annual gift tax exclusion states the amount yearly without being subject to taxation. The annual gift tax amount does not limit the number of people allowed to receive gifts each year. The gift tax cap does however, limit the valued amount of the gifts given annually. For instance, if the annual tax exclusion cap is $14,000, but the cumulative value of the gifts given was $15,000; the giver may be required to pay taxes on the remaining $1,000.

Lifetime gift tax exemption

Lifetime gift tax exemption is the total valued amount of a gift over the lifetime that can be given without having to pay gift tax. That valued amount will affect how much taxes will be taken out of any gifts given or transferred at the time of death. Because of this, it may directly affect the tax rate of any real estate gifts given at the time of death.

How the gift tax works

For the most part, all gifts are subject to taxation, but there are a few exceptions.

A taxpayer can give cash or a giftable item to one or more recipients, yearly. However, the taxpayer cannot receive payment for the gifts, unless the payment received is less than fair market value for the gifted item. A taxpayer can give one or more people each a gift that meets the annual gift tax exclusion amount and still avoid penalties on their yearly income tax return.

Gifts that are tax deductible are the gifts given to charitable organizations or contributions to the government. Giving a gift or leaving your property to an individual is not considered a tax deductible contribution.

What are not considered gifts?

Education and medical expenses. Paying all or part of someone’s college tuition or medical expenses counts as a gift tax exclusion. This includes paying the expenses directly to the facility.

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Charitable contributions to political campaigns.  Donations to political organizations are annual gift tax exclusions.

Contributions to government recognized charitable organizations. The government does not recognize all charities.  Always check if a charity is recognized and can be used for a deduction on the IRS website.

Gifts given to a spouse. If you give your spouse a car or piece of real estate, it is a gift tax exclusion.

Splitting annual gift tax exclusions between couples

Couples can give twice as many gifts as single taxpayers. For example, if the annual exclusion cap is $11,000, the wife can give a $11,000 gift while the husband can gift an additional $11,000 to anyone his wife gave to. Tax Experts often suggest that gifts given in the form of a check, signed by the individual spouse to avoid confusion at tax time. As of 2013, each couple can give up to $28,000 as a pair to each other.

It is important to know this only applies to married couples. The IRS does not recognize domestic partnerships, civil unions, or anything aside from a state recognized marriage.

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How federal gift tax affects estate tax

The gift tax originated to prevent someone gifting their estate before death to avoid the estate tax. The estate tax, like the gift tax, does not apply to spouses and charities.

The gift tax only affects the estate taxes of taxpayers whose assets exceed $5.49 million. There are ways to reduce, or even erase gift taxes even when the estate exceeds this cap. An easy way to stop gift taxes from affecting the amount of estate taxes is by boosting your amount of annual gift tax exclusions. Many have heard it said, “It is better to give while you are alive than wait until you are gone.” This may be truer than most realize. By giving away from your sizable assets throughout your life, you reduce the amount of estate taxes your family will owe at your time of death.

For example, say you have four dollars and you keep them until you die. Your family would have to file estate taxes, and 40% of that would be taken. They would be left with around two dollars, or half of what you had. Whereas if you gave them two dollars while alive, and kept two for yourself, after you pass away, they would be given one of those remaining dollars, so they would have three, instead of two.

How to spread gifts over a lifetime to reduce estate tax

Many tax Experts suggest spreading gifts out over the course of your life, to save your loved ones from paying high estate taxes. There are several ways taxpayers can acquire gift tax exclusions over a lifetime, for instance:

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Contributing to a 529 Plan. This means paying for your child’s, or another student’s, college tuition. With the 529 plan, you can spread contributions of $14,000 and $70,000 over five years as a gift tax.

Charitable contributions to political campaigns. Donations to political organizations are annual gift tax exclusions.

Contributions to government recognized charitable organizations. You may receive gift exclusions if you make a charitable contribution to a government approved organization.

Gift splitting. If you give $14,000 to a person and your spouse can give $14,000 to the same person, your household gifted $28,000 to the same person. You and your spouse would not be subject to gift tax because you each did not exceed the exclusion amount.

What form is required to file gift tax exclusions

Taxpayers are required to file taxes on all sizable gifts, regardless if a gift tax is owed. The Form 709: U.S. Gift needed for filing the annual gift tax. If you need a copy of a previously filed Form 709 you can do so by written request. To file this form, there is a fee which will be sent in with the form, paid by check or money order to United State Treasury.

Like most taxes, Form 709: U.S. Gift forms must be turned in by April 15th of each calendar year. If a taxpayer needs an extension on their regular tax return, the IRS may allow the taxpayer until October 15th. Form 1040 extensions also apply to Form 709: U.S. Gift tax returns.

If you are trying to lower your estate tax and need insight on annual gift tax or gift tax exclusions, ask a tax Expert.

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