Managing Money

Originally enacted as a protective measure to minimize estate and income tax avoidance by the very wealthy, the gift tax is often misunderstood; this confusion may cause unnecessary complications for even those of more modest means when the rules are not followed properly.

The gift tax is owed when an individual makes a gift to another individual. According to the IRS, “You make a gift if you give property, or the use of or income from property, without expecting to receive something of at least equal value in return.”

Fortunately, the rules provide for an annual gift exclusion, which allows individuals to transfer gifts up to a certain amount each year ($15,000 for 2021) without triggering gift taxes. The annual gift exclusion is a per person limit, which means you may gift up to $15,000 each year to as many individuals as you would like without any gift tax consequences.

Married individuals are entitled to their own annual gift exclusion; couples can give any one individual up to $30,000 per year. This is true even if the entire amount comes from one spouse’s bank account, which is known as “gift splitting” and must be reported on IRS Form 709 – “United States Gift (and Generation-Skipping Transfer) Tax Return.”

To illustrate how the annual gift exclusion works, let’s consider the example of Emilia and John. They would like to gift the maximum allowable, without exceeding the annual gift exclusion, to their son Craig, and his wife Jasmine, to help with the down payment for their first home. In this case, Emilia may gift $15,000 to Craig and another $15,000 to Jasmine, while John may also gift $15,000 to Craig

and $15,000 to Jasmine, for a total of $60,000.

It’s important to note that the IRS deems virtually any transfer of property as a gift, and sometimes individuals inadvertently run afoul of the gift tax rules by completing a transfer they didn’t realize constituted a taxable gift. For example, an elderly parent makes a taxable gift when adding a child as a joint owner to his or her home, which is not an uncommon practice for a widow(er) to do to avoid probate at their death (but something I typically don’t recommend). In this situation, the parent’s gift is equal to one-half the value of the home, which, assuming it exceeds the annual exclusion amount, should be reported on IRS Form 709.

Other transfers some may not realize are potentially taxable gifts include the sale of property below fair market value (the difference between the market value and the sale price is considered a gift), forgiving a loan, interest free loans or ones with an interest rate below the IRS Applicable Federal Rate (the forgone interest is considered a gift), and even 529 plan contributions, to name a few.

With regard to 529 plan contributions, Section 529(c) (2)(B) of the Internal Revenue Code details a special fiveyear gift tax averaging rule, which allows donors to spread a single contribution, in equal installments, over five calendar years for gift tax purposes. This allows an individual to “superfund” a 529 plan with up to a single $75,000 contribution ($150,000 for married couples based on five times 2021’s $15,000 annual gift exclusion) without triggering a taxable gift. Be careful here, though, because there are special rules and reporting requirements when using the superfunding strategy.

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Note that there are several instances when a transfer of property does not count towards the annual gift exclusion and is not subject to the gift tax. Examples of these are gifts to nonprofit organizations, gifts to political organizations, direct payments to educational institutions, direct payments to medical providers and gifts between spouses.

Many believe that the recipient of the gift is the party responsible for the gift taxes, but it’s actually the donor who is typically responsible. However, the reality is that most individuals will never have to pay gift taxes, even if a gift exceeds the annual gift exclusion amount. The reason for that is, in addition to the annual gift exclusion, individuals have a lifetime gift exemption amount of $11.7 million for the 2021 tax year (set to drop to $5.49 million in 2026).

When a gift exceeds the annual gift exclusion, the donor may elect to use the lifetime exemption to avoid paying gift taxes. To use the lifetime gift exemption, however, donors must file IRS Form 709 when a gift exceeds the annual gift exclusion amount. Failure to do so may result in taxes and penalties.

MARK A. KEEN, CFP®, IS PARTNER, KEEN & POCOCK, AND AN INVESTMENT ADVISER REPRESENTATIVE AND REGISTERED PRINCIPAL OF THE STRATEGIC FINANCIAL ALLIANCE INC. (SFA). SECURITIES AND ADVISORY SERVICES ARE OFFERED THROUGH SFA.

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