Saturday, February 25, 2012

What Free Gifts?

Everyone gets such a great feeling from getting a gift, especially since it is usually something unexpected, something we wouldn't get for ourselves, and it shows the feelings of the giver.  It also feels great to give gifts to others, but we have to beware that the act of gift giving may not always be free.  Yes, I am talking about a gift tax.

I was really surprised when I heard about such a thing, but it actually won't apply to most gifts.  First, what does the IRS define as a gift?  It is any property given without expecting to receive something of at least equal value in return.  That's pretty straightforward.  So do you have to beware of all the gifts you ever give here on out?  Let's first look at why there is a gift tax.

The main reason a gift tax exists is to prevent people from escaping an estate tax.  An estate tax is essentially a death tax: your right to transfer property at death gets taxed.  It is named an estate tax to sound a little less nefarious; I mean, how would you feel if you heard that you get taxed to die.  Of course, for most people, this might not kick in.  Starting with deaths in 2010 and beyond, you only have to file the specific estate tax form if you have more than five million dollars.  Some of us will most likely become that wealthy by the time we die, but a lot of us won't so it probably isn't as much a concern.  However, you can see how easy it is to avoid this tax if you just give all your wealth to your descendants before you actually die.  And that is where the gift tax steps in.

So, what will kick in the gift tax?  We get a pretty big break since the IRS doesn't want to unnecessarily tax normal gifts, just gifts that are trying to avoid the estate tax.  Starting in 2009, all gifts up to $13,000 to a person in a given year can get excluded.  There is also an exclusion for educational expenses, if you pay a child's college tuition for example that is more than $13,000 a year.  If you do give someone more than $13,000 in a given year as a gift, however, you will have to file a gift tax return.

The other benefit is that there is a unified tax credit that will get subtracted before you actually have to pay taxes on anything.  I believe starting 2013 and onward, the credit is $1,000,000.  Why it is such an arbitrary number, I have no idea.  But for example, let's say you give someone a gift of $20,000.  $13,000 is automatically excluded because of the annual exclusion.  The remaining $7,000 will be subtracted from your unified tax credit.  When this credit hits zero, you will have to start paying taxes on those gifts.

So even if it seems like gifts are taxed, for most of us, it won't kick in until we are much older, much wealthier, and want to move assets to the future generations of our family.  But it is still good to keep in mind that these gifts do trigger a tax.  Thankfully, we probably won't have to worry too much about it for a long time.

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