Gift Tax: The Tax Advantage That Keeps on Giving
The Internal Revenue Service never promised its rules and regulations would remain simple or easy to understand, but the IRS does a pretty good job of making them fair. One example of this, giving gifts, involves what many call “the gift tax.”
On the up side of things, when you give a gift, you can often earn a deduction for it. Typically, altruistic gifts earn a deduction.
Examples of Gifts that You Can Deduct
Your charitable donations or political organization donations, gifts to your spouse (aww), and when you pay the medical expenses or tuition of another person. There is also an annual exclusionary amount each calendar year that – so long as you do not exceed it – you will not owe taxes on gifts.
You probably sit there and read that and think, “Okay, give me an example of what IS taxable because I was thinking charity gifts.”
Okay. As a businessperson, here are my thoughts off the top of my head.
The gifts you gave the guest speakers you invited to your child’s club that is not a 501c(3) or you had speak for your new startup’s organizational that you bought yourself qualify.
When you bought your teen a car for their birthday.
The rent you paid for your mother-in-law when she visited for three months and stayed in a residence hotel because you had not yet finished her mother-in-law apartment.
Those types of items and any other present or gift that you personally bought; you owe taxes on it.
Bummer?
Yes and no.
Gift taxes encourage you to give altruistically. You can avoid paying federal tax on something though or reduce the amount owed by giving it as a tax.
Gift Tax Specifics
You incur the gift tax, aside from the above-named exclusions, when you transfer property from one individual to another without receiving equal value in return. So, you would still incur some gift tax if you sold a property worth $250,000 for $1. The IRS sees right through that. Hmm…
Here are a few other things you might not have realized qualify as gifts.
You give someone money (except your spouse).
You allow someone to use something for free that typically costs money, like letting a friend live free in your rental house. You made a gift of the rent.
Items you sell at less than the full, market value.
If you make a reduced-interest loan or an interest-free loan, it can be considered a gift.
How to Learn the Nitty Gritty
Let’s say you love to read. This blog post just will not sate your appetite for learning about gift tax. The IRS wrote the book on that. No, I am serious. The IRS literally wrote a publication on gift tax. It is affectionately known as Publication 559 and you can download it from the IRS website. You might also want to download Forms 706 and 709 plus their instructions.
Perhaps that much reading does not resound with you. It is not for everyone. You could also talk to a real, live person. – a tax manager.
The short version is that if you give the gift, you, the donor, pay the tax on it. You can make an arrangement with the donee – the person or organization to whom you give the gift.
You can reduce that taxes you owe overall by donating to charity. When you give to a non-profit, 501-C3, you avoid paying gift tax on it. You also earn a deduction.
If you and your spouse file jointly or separately, you each get to take the annual exclusion. So, if you want to give your child $34,000, you can each give the child $17,000, the 2023 exclusion, and neither of you pats gift tax. Your child will not pay tax in the gift either, typically.
Gift Tax vs. Estate Tax
Gift tax and estate tax are two very different things. When someone passes away, the items and properties they bequeath in their estate or will not incur tax for them. The person who inherits them pays the taxes. Not every amount left to someone gets taxed. If you leave a large estate though, it will incur taxes that the people who inherit from it will pay. The amount changes annually because the IRS recalculates the cap per the economy each year.
While that might sound a bit busy and complicated, it can help you. That is because the IRS typically increases the cap. Yes, the government actually says you get to leave a larger amount to your heirs.
For those who love to read, the IRS wrote the book on this topic, too. It is free. Most IRS publications are. You can learn about the ins and outs of estate taxes by reading IRS Publication 559, entitled “Survivors, Executors, and Administrators.”
Of course, you need to prove to the value of the gift. You do this by including copious amounts of documentation to make the IRS happy. Here is a short list of items the IRS likes to see with your return when applicable to your gift. Always send a copy of the original document, not the actual document.
appraisals
relevant transfer documents
partially-gifted assets documentation
What is the IRS looking for with all these documents?
Essentially, the first thing is to make sure that the Fair Market Value gets reported accurately. That refers to 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.”
That differs from the forced sale price. It also is not determined by the actual sale price. This is why before you sell a home, the realtor tells you that you need an appraisal. This provides a base line of value. You need to do the same thing for any gift that is not money.
While the IRS does not give advice on who you should hire to handle your taxes or the property transfer or donation, you should consult an attorney for each gift that exceeds the annual limitation.
Also, at that level of gifting, you have likely exceeded your ability to complete and file your own taxes, unless you happen to be a certified public accountant (CPA). Even then, you probably should go to a different CPA to have them do your taxes. I say that because every CPA I know does exactly that.
If you have not needed a CPA or attorney to handle financial matters to this point, the easiest way to find a good one is to ask for referrals from business associates and friends.
Selling a gift
While you do not pay taxes on a gift that is given to you or inherited, typically, you will pay taxes if you sell a gift given to you for a profit. So, if your dad gives you a stock worth $10 per share and its value increases after you receive it, then you sell it for $100 per share, voila , you owe income tax on the $90 per share profit you made.
The Spousal Rule
The IRS includes some pretty forward-thinking folks. For much longer than other areas of the government, the IRS has viewed marriages of any gender combination as a lawful marriage. The Service counts it even if you married in a state where same gender marriage is legal, but then moved as a couple to a different state where it was not. Here’s the thing. Regardless of the genders of the individual, the gifting exception does not apply to the following:
civil unions,
registered domestic partnership,
other formal relationships not denominated as marriage under their state’s law.
I do not know how many people really consider the financial aspects before getting hitched, but if you are vacillating between actually getting married or simply going to the justice of the peace for a civil union, then choose the wedding. You can give your spouse gifts to reduce your income taxes.
Reduce Capital Gains Tax
By now, you might be put off of giving gifts or charitable donations because of all the gift tax rigmarole. Give anyway. Not only is good for the soul, but you are helping yourself in the end, too.
Charitable donations can help you reduce the amount of capital gains taxes you owe. You can do this in a number of ways.
Give a cash gift.
Give a gift of stock.
Give a gift of an in-kind donation.
While cash proves the most common option, you can do more good by donating the other two options. You also receive the same deduction either way and reduce your capital gains taxes by donating stock.
Stock lets your initial gift continue to grow. Let’s say most of your portfolio has done well, but you feel ready to re-balance it. Rather than selling something off, you can give one of the stocks you choose to get rid of as a charitable donation. This reduces the amount you owe on the earnings of the portfolio, re-balances you and provides you with a nice gift deduction.
Here is what makes a stock gift so cool. Even if it has not performed as you had hoped, the stock you donate has value. It is part of the constantly fluctuating stock market and it could and probably will increase in value in the future. When it does so, the gift you gave continues to give. The charity can sell it and use the profit without incurring taxes on it – a wonderful facet of 501c3s.
Donation of in-kind
Another option is a donation of in-kind. In-kind what you ask? Anything. You can donate your services, but document it at the value of your skilled or professional time. You can donate materials, such as building materials. You can donate office supplies or office space. If you can give it and it has a tangible, fiscal value, you can donate as an in-kind donation.
If you ever wondered how Habitat for Humanity or Christmas In April homes turned out so cute and had so many fancy windows or upscale doors or exquisitely tiled floors, in-kind donations are the secret. When I worked as a VISTA, now more commonly known as the AmeriCorps, one of my assignments was at the Christmas in April in Oklahoma City, OK. Many companies, as well as their C-level leadership, volunteered and the companies donated materials and services. Those homes turn out so beautifully because companies that consisted of some of the largest builders and most highly skilled artisans gifted their time.
Documenting the Documentation of Your Gift
If that sounds redundant, remember, this is our good ole US government we are talking about here. Arbor Day, they plant trees. The rest of the year, they kill them via paperwork.
As part of the documentation you should keep, you need a copy of the IRS account transcript for gift tax returns. By now you are a pro at the IRS website, so here is another form for you to download. You need to fill out and file Form 4506-T, a Request for Transcript of Tax Return. Submit it with substantiation via mail or fax. (They not to laugh that they still use fax.)
Once the IRS gets the form; they verify that you are you. They will match your current taxpayer and taxpayer representative records with what you submitted on Form 4506-T. After that, they will help keep the US Postal Service going by mailing you a hardcopy transcript to your address of record.
Be careful filling out the form. While taxpayers may grouse sometimes, the Service goes pretty far to protect them and their privacy. If they receive an incomplete or unsubstantiated request, they will not provide the transcript. They will send a rejection notice to the Requester.
If you properly completed it, you get your transcript. This is a fee free transcript.
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Tip: Always leave lines 2a and 2b blank.
If you are completing it to obtain records for a deceased individual’s file, line 3 requires the estate representative's name, title and address. It has to match the official IRS record.
You also must include documentation if the donor has died. The Personal Representative/Executrix/Executor must include specific documentation to obtain the transcript. This includes Letters of General Administration or Letters Testamentary or a similar Court document.
Let’s say there was no probate. The surviving spouse handled the estate themself. They need to complete the same form, but include a statement that says no probate commenced or will do so in the future. They must also include a copy of the marriage certificate. Wherever the form asks for a title, enter "Spouse."
There are other requirements for different individuals. For example, when a Trust Officer requests the information, their employer - the Bank or Trust Company – has to prove it is authorized to receive that taxpayer’s information. The Trust Officer also must submit valid identification.
Additional Documentation
Tax professionals have additional forms and documentation to submit. They have to also include a copy of the first Form 2848, aka Power of Attorney form, submitted to the Service for that taxpayer and the matching tax year. It cannot be new Power of Attorney although they also need to have current PoA, too.
Just as with the other form, it the Form 2848 arrives at the IRS incomplete or unsubstantiated or is a duplicate, it will be rejected. You must first submit the Form 2848 to the CAF Unit. IT must be an original and accompanied by substantiation. Only this method processes a valid Power of Attorney.
After you submit the Form 2848, you can submit the request for the transcript to the main IRS address. (There is no special unit for this form.)
Final thoughts
Do not let the gift tax put you off of giving. The only time you really incur it is when you give a large gift to an individual or to a for-profit entity. The IRS rules work to encourage altruistic giving. You can help yourself save money at tax time and help others by giving a gift. Remember to consult your attorney or Certified Public Accountant (CPA) before making a major gift. They will know the ins and outs better than your financial planner, a common source who suggests such gifts to help reduce your tax burden.