Wednesday, June 27, 2007

The Gift Tax explained

Many people may be confused about what the IRS' gift tax really is. I myself was pretty confused about it. The common misconception is that every year if you give a substantial gift, you have to pay taxes on it if you give over a certain amount (excluding certified charitable organizations). You can certainly get that impression when you read the IRS gift tax summary, specifically:

If you gave any one person gifts in 2006 that valued at more than $12,000, you must report the total gifts to the Internal Revenue Service and may have to pay tax on the gifts.

Of course for most people we really don't pay any taxes at all. All individuals (even married people filing jointly count as two individuals) have an annual and lifetime limit on the amount of the gifts they can give without tax. As of 2006 the annual limit is $12,000. However only yearly amounts above that could you be possibly taxed on. If you gave $13,000 you are only liable for $1,000, but you still don't have to pay taxes on it yet.

Here are the details of the annual exclusion from IRS publication 950:

A separate annual exclusion applies to each person to whom you make a gift. For 2006, the annual exclusion is $12,000. Therefore, you generally can give up to $12,000 each to any number of people in 2006 and none of the gifts will be taxable.

However, gifts of future interests cannot be excluded under the annual exclusion provisions. A gift of a future interest is a gift that is limited so that its use, possession, or enjoyment will begin at some point in the future.

If you are married, both you and your spouse can separately give up to $12,000 to the same person in 2006 without making a taxable gift.

So the limit applies to gifts given from one individual to another. You can give ALL your money away in $12,000 increments to as many people as you want for the rest of your life and not pay a single dime in gift taxes.

If you are married, you can combine your excluded annual amounts:

In 2006, gift splitting allows married couples to give up to $24,000 to a person without making a taxable gift.

For individuals, even if you are filing a return for a gift tax you do not owe any tax until you reach the lifetime exclusion amount, which is $1,000,000. That's $1,000,000 for each person you give to. To reach that limit, I would have to be giving you a heck of a lot of money. I'd need to "gift" to you $32,000 for the next 50 years in today's dollars not adjusting for inflation (and the gift tax exclusions do adjust for inflation) before I would have to pay any taxes on the money I gave to you.

I think that amount of gift giving is out of the range of most middle class Americans. For the majority of us, the gift tax just doesn't apply. In other words, don't sweat over it.

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