Are Gifts Taxable?

Thinking about giving somebody some money? If so, you should consider the federal gift tax rules (as opposed to income tax rules) before you give. Generally the gift tax rules allow you to make a gift of $11,000 per year to any individual without gift tax consequences. The gift may be made in cash or property, but the value of property counts toward the $11,000 limit. There is no limit on the number of people to whom you can give. Also, there is no limit to the amount that you can give to charity; however, your tax deduction may be limited. Income tax deductions for charitable contributions not allowed in one tax year may be carried over to the next tax year.

There is no dollar limit on the amount you may pay on an individual's behalf if you pay the money directly to a school for tuition or to a health care provider for certain medical costs. For example, a grandparent could pay the tuition costs for a grandchild, or a sister could pay the medical expenses of her brother. As long as the payments are made directly to the institution, the $11,000 limit will not apply.

The exclusion does not apply to books, supplies, and fees or other expenses that are not direct tuition costs, or for medical costs that do not qualify as deductions for income tax purposes.

There are some special rules that apply to spousal gifts. You can give unlimited gifts to a spouse. Spouses also have the option to split their gifts so that a gift made by one is treated as being made one half by each. As a result, a married couple can give $22,000 a year to any one individual without incurring any gift tax. The funds can come from one spouse's assets, as long as the couple agrees to split the gift.

There are no income tax consequences to the recipient of the gift. The donor pays no tax for each gift under $11,000 a year, and does not receive any income tax deduction for the amount of the gift given (unless made to a qualified charity). However, if gifts exceed $11,000 per recipient per year, the donor is subject to the gift tax rules.

Under those rules, every person is entitled to a combined lifetime exemption of $600,000 for gift and estate tax purposes. This exemption allows an individual to transfer, either during lifetime or after death, $1,000,000 of assets without paying any gift or estate tax. (In the year 2004, the estate tax exemption rises to $1,500,000 while the exemption for gifts will remain at $1,000,000  All will change again after 2011, when this tax law expires due to the sunset provisions; see your tax professional for more information.)

While the actual regulations are complex, the concept is that for every time an individual exceeds the $11,000 limit, his or her lifetime exemption is reduced by the amount of the gift above that limit. For example, if you give someone $15,000 in one year, you would be required to file a gift tax return. You would not be required to actually pay any tax; instead, the information return would reduce your lifetime exemption from $1,000,000 to $996,000.

If in a later year you gave a $25,000 gift to someone, you would again file a gift tax return and reduce your lifetime exemption by $14,000, from $996,000 to $982,000. If you made no more taxable gifts during your lifetime, your estate would be entitled to a $982,000 exemption at your death. Although you would not pay any taxes in the years that you made the gifts, a larger portion of your estate could be subject to the estate tax when you die.

The gift tax rules do provide some planning opportunities. One tax advantage of giving gifts now is that you can lower the value of your estate, thereby minimizing any potential estate or transfer taxes when you die. If you transfer property that will grow in value, that growth occurs outside your taxable estate.

Another gift strategy: if you transfer income-producing property, the income will be taxed at the donee's income bracket, which in many cases is lower than the donor's tax bracket. If you are placing assets in a trust for minors, complicated trust tax rules may apply.

It is also important to look at the ramifications of gift giving in regard to Medicaid planning. The rules are very complex and an innocent mistake could disqualify the donor from ever being eligible for Medicaid should they need to apply for it at some future time. Before making any large gifts it is best to consult your tax advisor and to seek the advice of a financial advisor who specializes in Medicaid and Medicare planning.

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