The annual gift tax exclusion in 2018 allows up to $15,000 to be transferred tax-free. Meaning cash gifts received or made, from anyone, over that limit are taxed. If you’ve ever received a generous gift from someone, you might be wondering who pays gift taxes? How does the gift tax work? And why is there a gift tax? This article will explore that and more as we dive into the gift tax annual exclusion and planning opportunities it presents. If your parents or grandparents ever bring up the discussion about gifting, you might be able to impress them with this valuable insight!
What is the Gift Tax?
The gift tax is used to tax the transfer of cash or property from one individual to another. Regardless of whether that person is family (unless it’s your legal spouse), the gift tax applies. In 2018, gifts of cash or property valued at $15,000 can be transferred tax-free to an individual. For example, if you’ve ever received $100 gift cards on your birthday, you don’t have to worry, you haven’t skipped the IRS on gift taxes. It’s less than the annual exclusion amount and therefore doesn’t require you pay taxes.
Gifts of cash are fairly straightforward. However, when it comes to gifting property, it can get a bit more complicated. For example, let’s say you’re selling your car that has a market value of roughly $15,000. You’re brother or sister decides they want to buy it, and because you’re a great sibling you decide to knock off $5,000 and sell it to them for $10,000. Had you sold it for the “fair market value” there would be no gift taxes since it’s under the annual exclusion limit. However, because you’ve discounted the sale, the IRS views the difference between the sale price and the fair market value as a taxable gift.
You also can give gifts to multiple people in a year and not worry about the gift tax. For example, if you’ve won the lottery and decided to give your entire family of 4 each $15,000, you would fall under the annual exclusion for each individual and not owe any gift taxes.
Who Pays Gift Taxes?
The person doing the giving pays the gift tax and they’re responsible for filing with the IRS. One item to note is everyone receives their own lifetime gift/estate tax credit. The credits can be applied to a person’s lifetime gifts to offset gift or estate taxes (any credits leftover at death can be used to offset estate taxes). For the majority of people, this credit is more than enough to offset any gift taxes they would otherwise have to pay throughout their life (in 2018 this credit amounts to $11,200,000 in taxable gifts).
The gift tax was implemented to ensure that wealth isn’t passed in perpetuity from one generation to another. Over time, that would allow an insane amount of compounding and probably result in an even greater wealth divide than we see today! Although, for wealthy individuals or families that fail to plan how their assets are to be transferred when they pass, the tax bill can be enormous. The great artist Prince died without a will or estate plan in place and owed roughly $100 million in estate taxes, which with proper planning in place and gifting during life, could have been reduced.
How Does this Apply to Millennials?
Gift taxes are typically something only the wealthy have to worry about. Which usually means they’re older individuals who’ve had years income and investing to build up sizable net worths. However, Millennials are set to inherit trillion’s of dollars in the largest wealth transfer ever. The transfer will take place over many years, and for some Millennials not until they’re actually set to retire themselves. This brings up the point though that strategically passing assets to family members, charitable organizations, or even friends, should be discussed amongst the person doing the giving and the person/organization receiving.
Utilizing the annual gift tax exclusion of $15,000 per individual in 2018 allows someone to transfer money essentially tax-free. If they plan early enough they can transfer more money tax-free and result in a larger gift for the inheritor.
This conversation doesn’t have to come across as being entitled. Sure, asking your parents or grandparents how much you can expect to inherit can be an uncomfortable question and come across as if you ARE expecting something. But that’s really not the point. The point is to engage in a conversation about money. If you learn that you, in fact, are set to inherit something, ask your parents or grandparents what do you envision this money or property being used for? Ask if they’ve implemented a will, or planned how to transfer the assets? Money is a touchy subject, sadly even among families. If approached the right way, opening up about the subject can actually deepen relationships and lead to a greater understanding of one another.
Planning Opportunities around Gifting for Millennials
There are several planning opportunities surrounding the gifting of assets. A few that might apply to Millennials are funding college education in a tax-effective manner, or establishing a charitable fund.
Let’s say you’ve learned through conversations with your parent’s or grandparent’s, they wish to provide funding for your children’s college education costs. One way they could go about it is to gift the cash directly to you, in which case they’d be making a taxable gift if over the annual exclusion amount. Instead, because they’ve stated they wish to provide for education costs, they could make a contribution to a 529 account. The annual gift tax exclusion applies to the 529, however, they can make a contribution of up to 5x the amount in one year. That would equate to $75,000 in one year towards college education that could be gifted tax-free (double that amount if they’re married)!
Now let’s assume instead your grandparents or parents are interested in gifting a sizable portion of their assets to charity but are unsure of which charity to gift to right now. Donor-advised funds allow individuals and even families to make contributions to an account, receive a charitable deduction on income taxes in the contribution is made, and invest the funds for charitable grants in the future. For example, maybe your grandparents wanted to establish a legacy of giving by incorporating the entire family in the giving process. Every family member could contribute, however large or small, to the donor-advised fund, and decisions about which charities to grant the money to could be made at a later date as a family!
These are just two strategies involved in the gifting of assets and achieving their respective goals. Again, these strategies can only be utilized when conversations have been had about money within the family dynamic. It can help ALL parties involved.
If you want to have open conversations with your spouse or family members, schedule a free consultation with us today. Oftentimes it’s helpful to have a financial professional moderate conversation and lead to a joint understanding between the individuals involved.
Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR™ and Co-Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!