It's a wonderful time of the year, when we think of family and friends, and giving gifts. If you're in the fortunate good financial position to give gifts of substantial value, such as fine art, stock, or just a big fat check, it's important to think of the IRS at times like these.
Some Key Points to keep in mind are:
- You can give up to the value of $14,000 to any number of people this year without triggering gift taxes.
- Anything above the $14,000 limit has to be reported and counts toward your lifetime exclusion.
- Best to know the rules before giving that artwork or writing that generous holiday check.
How do gift taxes work? What does that means tax-wise for you—or for those lucky ones who get your gift?
It's great that you are in a position to give a large valuable gift. If you're making a gift to your children (many of us are big believers in one generation helping the next), the holidays are an excellent time to share good fortune. And, for most people, gift taxes aren't an issue. But what if you're part of that lucky crowd that does benefit from gift tax exclusions?
Current gift tax laws allow for a hefty exclusion for you, the giver, so gift taxes affect only a small percentage of the population. Plus, gifts aren't considered income to the receiver, regardless of the amount. Also, estate and inheritance taxes—which go hand-in-hand with gift taxes and share some of the same exclusions—usually affect only the super wealthy.
But with times being what they are—and taxes being a hot topic—it's smart for everyone to understand the basics. You may be aware of how gift and estate taxes work, but here are some numbers you might want to review to fully understand and appreciate a big valuable gift.
What you can give tax-free annually
Technically, the IRS considers any gift a taxable gift, but right now, an individual can give up to $14,000 a year to anyone—and any number of people—without incurring gift taxes, or even having to report the gift. That means you can give $14,000 to anyone you want, without having to tell the IRS about your gift and without having to worry about paying taxes on your gift. You can give each person you want $14,000 without worrying about taxes. Yes, if you have 5 different people, do the math, that's $70,000.
Married couples can choose to split their gifts for the calendar year to give up to $28,000 a year. For example, your parents could combine their annual limit and give each of their children or grandchildren up to $28,000 during this 2016 holiday season—and no one, not you or your parents, would have to pay taxes or even report the gift. However, if your parents decide to do this for one gift, they must split all other gifts during that year. And, although there would be no gift tax due, they would each have to file a gift tax return (IRS Form 709).
By the way, if your parents decide to fund your tuition or medical expenses, those payments would not be considered taxable gifts and aren’t included in the annual limit. So, by paying your tuition or taking care of your medical expenses, they could give even more without worrying about tax.
What is a lifetime exclusion and how does it work?
If you limit giving to the $14,000 annual exclusion, giving valuable gifts can be simple. Things get complicated when you give more than $14,000 ($28,000 for a married couple) to any one person during the course of a year.
You may have heard of the lifetime exclusion. This is the amount you can give above and beyond the $14,000 annual limit during your lifetime without getting hit for gift taxes. For 2016 that amount is a whopping $5,450,000, and will go up to $5,490,000 in 2017.
With such a high limit, the vast majority of people won't need to worry about paying gift taxes. But whether or not you ever reach the limit, you are required to report any gift that's more than the annual limit—$14,000 this year—and it's whatever you give over that amount that counts toward your lifetime exclusion.
Here's an example. Let's say you want to give four people $25,000 each this year—$11,000 per person over the $14,000 annual exclusion. The rule is you can give them each $14,000 without paying a gift tax. So, in this case, you would be giving $44,000 totaled toward your lifetime exclusion that must be reported. If you're an art collector and you have four artworks that are valued at $25,000 each, it works the same way when you decide to give them as gift to four different, and lucky, people..
An important qualification
Another thing you should be aware of, when contemplating giving large gifts, is that to qualify for the exclusions—both annual and lifetime—a gift must be of present interest, which means that the recipient has an unrestricted right to the immediate use of the property. That means that the person you're giving your gift to must be able to do anything they want with your gift—such as sell the artwork or cash that check in for anything they want. A gift of future interest, which is restricted in some way by a future date, doesn’t qualify. Gifts of cash and property where title passes immediately are examples of gifts of present interest.
A word about estate and inheritance taxes
For the record, gift taxes and estate taxes are related. One rules how much you can give away tax-free during your lifetime; the other rules how much you can give away on your death. For federal tax purposes, the exclusion limits are the same ($5,450,000 for 2016, and $5,490,000 in 2017). These exclusion limits are the value of your whole estate, which includes personal property (things like artwork, cars and jewelry) and real estate (your home, vacation home, etc.), and are taxes that only affect a small percentage of the population.
However, some states also have estate or inheritance taxes (in some cases, both) with exclusions lower than the federal limits, which makes gifting during your lifetime a good strategy to reduce your taxable estate. Check into the tax rules for your state, and if estate or inheritance taxes are a concern, factor that into your giving strategy.
What is it worth?
Your cash gifts are worth the face value of the gift—a check for $14,000 is worth $14,000. But if you're giving a piece of art, have it appraised for fair market value, the value it is worth when you gift it. The appraisal value is the value the IRS will be interested in when looking at your gifts and taxes. See our earlier post, about why you should hire an appraiser here.
Making the most of the gift
Your generosity can mean a lot to your family financially, but it also provides a great opportunity to sit down and talk about saving, investing and how to make money grow. Talk to your kids about setting goals, budgeting and thoughtful spending. Consider opening a custodial account to teach your children about investing. And, while you're discussing these things, take a fresh look at your own finances.
To me, while you're all lucky to receive this holiday windfall, the chance to focus as a family on wise money management could be the greatest gift of all.
Micaela Contemporary Projects does not provide tax or insurance advice, nor is it qualified to do so. Clients and interested parties are advised to contact a tax or insurance-related professional in all matters regarding these two areas.