I was having a conversation a few days ago with a man who wanted to preserve as much as he could for his family - and as little as he could from the government. It was a difficult conversation to have because - in spite of his confident nature - everything that came out of his mouth was wrong.
While he was on the topic of gifting, he said, "I want to put some things in my daughter's name, but if I give her more than $14,000 in any year, she will have to pay tax on it."
We hear this often. And every time we hear it, it's wrong.
The Technical Side of Gifting
Here's the technical side of gifting. Each year a person can donate $14,000 (or whatever the present interest annual exclusion amount is - it gets adjusted for inflation) to as many people as they want and there are no TAX CONSEQUENCES to that donation. Most people understand this.
But where most lay people misinterpret the law is the following. Any gift, regardless of the value of the gift, is exempt from income tax both to the donor (the person making the gift) and the donee (the person receiving the gift). That's right. If Dad gives $114,000 to Daughter, no one pays any income tax.
So, what's the catch?
The $114,000 gift described above is a TAXABLE GIFT. But no one pays any income tax. Here's the only tax consequences. You see, Dad has an estate and gift tax exemption of $5.49 million. By making a $114,000 taxable gift, no one owes any tax. Dad must report to the IRS (on a Gift Tax Return - IRS Form 709) that he made a taxable gift. But no one owes any taxes. Dad simply used up $100,000 ($114,000 - $14,000) of his gift and estate tax exemption. Now, when Dad dies, instead of being able to exempt $5.49 million free of the 40% estate tax, Dad can only exempt $5.39 million of assets from the 40% federal estate tax.
When Dad learns this he exclaims, "I'll never have anywhere near an estate of more than $5 million so making a taxable gift really doesn't matter in my circumstances." Congratulations Dad! You now understand that making gifts in excess of the present interest annual exclusion amount (currently $14,000 for gifts made in 2017, but subject to increase) causes no one to pay any tax.
Gifting can be tricky. If you're gifting, you can make some big mistakes if you don't take into account all of the income tax, capital gains tax, property tax, estate and gift tax, and other nontax considerations that result from making gifts. Some families benefit from giving cash, while others may benefit from giving appreciating assets. Some families lose out when they donate appreciated assets. So get some expert help and have a good estate and tax legal program in place for your family to preserve and protect what you have.