We work hard for our money during our lifetimes. We sacrifice, we save, and we invest. With that hard work, many people find it highly rewarding to show generosity to others. Unfortunately, the IRS views generosity skeptically, and we are not allowed to freely give our money to others without potential tax consequences. The reason for this is the estate tax. Essentially, the IRS believes that if people were allowed to give gifts without tax consequences, people would simply dissolve their estates by giving everything away in order to avoid the estate tax.
What Constitutes a Gift?
The IRS defines a gift as “Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” Notably, there is $14,000 annual “gift tax exclusion” for individual donors and $28,000 for married donors. What this means is that an individual can give a $14,000 gift to as many people as they want, which the IRS cannot tax. You could hand out checks for $14,000 to five thousand people without tax consequence. In addition, the $14,000 is the maximum, so you can give multiple gifts to the same person, so long as the total does not exceed $14,000.
Significantly, beyond the annual exclusion, there are three other types of gifts that are exempt from the gift tax. This includes: (1) tuition fees and medical expenses that you pay directly; (2) gifts between spouses; and (3) donations to political organizations.
Lifetime Gift Tax Exemption
In addition to the annual gift tax exclusion, there is a “lifetime gift tax exemption” of $5.45 million for the 2016 tax year. This means that over your lifetime, you can give a total of $5.45 million in gifts (beyond the $14,000 per person exclusion), before you are subject to a gift tax. For example, if you gave a nephew a $25,000 check for graduating college, $14,000 of that amount would be automatically excluded from consideration, leaving $11,000 in taxable gifts. That $11,000 would directly reduce your $5.45 million lifetime limit.
If this lifetime exemption seems oddly specific, that is because it is directly tied to your estate tax exemption. So every dollar that is deemed a taxable gift directly reduces your estate tax exemption when you pass away. This means that if you give away $4 million in gifts over your lifetime, your estate tax exemption at the time of your death has been reduced to $1.45 million.
Effectively managing your taxes requires a big picture approach. That is something that the Law Offices of Robert S. Thomas can offer you. You need a skillful attorney who can help you navigate your short term and long term tax goals. I have been a tax attorney for over two decades and have a Master of Law Degree (LLM) in Taxation, and a license to practice in the United States Tax Court. Contact The Law Offices of Robert S. Thomas at 847-392-5893 or visit our website today.