When we think of gifts we imagine Christmas day, someone’s birthday or a special event in someone’s life like a graduation. The first thought that pops into our head is not taxes. We think of gifts as tax-free, and generally they are, but lo and behold, the IRS is a tricky beast. If you make a gift of a substantial amount of money you might have to pay federal taxes on it. Let’s break it down:

The annual exclusion

You can give a gift of up to $14,000 to any individual or non-charitable institution once a year completely tax-free. This is called the annual exclusion because it is a one-time gift, once a year.

However, if you give someone over the $14,000 mark you are taxed on the additional cost. For example, if you gave your son a $20,000 gift, you would be taxed on the additional $6,000.

Married couples

Married couples have special rules when it comes to the annual exclusion. They can combine their annual exclusions and receive gifts of up to $28,000 tax-free.

How to use the annual exclusion

Although most people will not be making gifts that large it is worth keeping in mind just in case. Also, if you are wealthy you can use this exclusion to make gifts under the taxable rate on a yearly basis in order to give away your estate with lesser tax consequences.

The lifetime gift tax exemption

This tax really only applies to the wealthy. If you make gifts of over $5.35 million over the course of your lifetime you have to pay a gift tax on the portion of the gift that exceeds the $5.35 million. The rate of taxation is high so you could wind up paying a 40% or higher tax rate on the excess.

How to avoid it

The thing that works out for taxpayers is that they can avoid this by giving away their money under the annual exclusion. The Lifetime Gift Tax only applies to the portions of gifts given away that exceed the annual exclusion.

For example, if you make eight gifts of $14,000 to eight different people in a single year none of that would count towards your lifetime gift tax. But if you made one gift of $15,000 to one person, in one single year, $1,000 of that gift would count towards the lifetime gift tax. Thus, as long as you stay below the annual exclusion you will not have to worry about the lifetime gift tax and if you do go over the exclusion the excess must exceed $5.35 million in order to affect your pocket book.

Conclusion

Although we think of gifts as outside the reach of the IRS, that is not true. Gifts of large amounts of money are taxed by the IRS. In order to avoid these taxes take full advantage of the annual exclusion and keep a watchful eye on the lifetime gift tax exemption. Happy gift giving and good luck! I know I’ll be hoping for the gift of a new Ferrari one of these days and will happily pay the taxes.[1]