Most doctors need to conquer a decade of student loan debt before they can enjoy complete financial freedom.
So once you've officially made it, you may feel inclined to spread the wealth. Whether that means generous gifts to family members or donations to charities you care about, your generosity will should be welcomed.
But did you know large gifts can trigger tax obligations?
What is a gift tax?
A gift tax is assessed to the donor who makes a gift to another party. Gifts can include cash and/or property.
When you give property, it's assessed at fair market value at the time of the gift for gift tax purposes.
According to the IRS, fair market value is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
You must report gifts exceeding the IRS limit using Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
However, there are certain gifts that donors are not required to report for gift taxes purposes, regardless of size. These include:
- A gift to your spouse.
- Donations to qualifying charities. (Itemizing deductions actually allows you to subtract donations from your taxable income.)
- A gift made to pay medical or education expenses for another person. (You must pay the institution directly.)
What is the lifetime gift tax exclusion?
Even if you make gifts not covered by the above exclusions, it’s still rare to incur gift taxes. That’s because you are entitled to a lifetime exemption. In essence, this is a credit against gift and estate taxes you can incur instead.
The lifetime exemption increases each year to account for inflation. For 2018, the lifetime gift tax exemption and estate tax exemption is $5.6 million --- $11.2 million for a married couple.
Does that mean you’re limited to giving “only" $5.6 million over your lifetime without owing a tax?
What is the annual gift tax exclusion?
In addition to the lifetime exemption, there is also an annual gift exemption. For 2018, this exemption is $15,000 per giver --- $30,000 for a married couple.
The annual gift exclusion applies to a calendar year. So you can give $15,000 to a recipient on December 31 and another $15,000 on January 1 without incurring a gift tax.
That annual exclusion applies to each recipient. That means you and your spouse can give $30,000 to each of your children, or to as many people as you wish.
As long as a gift doesn’t exceed the annual exemption amount to a single recipient, you don't owe a gift tax that year. The gift also does not apply to your lifetime exemption.
For example, if as a single filer you make a $13,000 gift to one person, a $12,000 gift to another, and a $10,000 gift to a third, you will not owe any gift taxes for this year. In addition, none of these would affect your lifetime exemption.
But what happens if you exceed the annual amount? Say you gave $20,000 to a single recipient. You would owe a gift tax on the $5,000 that exceeded the exclusion amount.
You could then pay a tax for the year you file. You could also apply that $5,000 to your lifetime exemption.
As you can see in these scenarios, you would have to make very large gifts over a number of years before:
- You would owe gift taxes, or...
- Put in a dent in your lifetime exemption.
Any lifetime exemption amounts remaining when you pass will transfer to your estate. Only 0.2 percent of Americans owed estate taxes in 2013, so it’s unlikely the gifts you give will lead to estate tax obligations. In fact, many wealthy individuals use their annual gift exemptions late in life to reduce the size of their estates. That way, they can avoid owing estate taxes upon the transfer of assets.
If you do end up paying a gift tax, the rates range from 18 percent to 40 percent of the amount above the exemption.
With the proper planning, you express generosity to family and friends without ever being forced to pay a gift tax.
- What types of gifts are taxed?
- Lifetime vs. annual gift tax exclusions.
- How to handle gift taxes the right away.
If you do give significant gifts, should consult a financial adviser, tax professional and/or estate planning attorney to ensure your gifts are made in a tax-efficient manner.