The gift tax exclusion can offer huge potential tax savings during a person's lifetime. But in order for the exclusion to matter, there has to be a lot of money you are gifting away. In this article, I will explain how the Annual Gift Tax Exclusion of $14,000 for 2017 works, why most people get it wrong, and a very important warning when you are giving money to a non-US spouse.
Getting the Most Out of the Gift Tax Exclusion
First, the basics on the Gift Tax Exclusion: In 2014 the Gift Tax Exclusion was raised to $14,000 and has remained there at the time of this edit (February 2017). Basically, the exclusion allows a person to give gifts valued at up to $14,000 to a single individual per calendar year without paying federal taxes. This can be a single gift, such as a $14,000 car given to a child, or multiple gifts given throughout the year; provided that the cumulative value does not exceed $14,000.
It should be pointed out that this $14,000 limit is applied per individual. There is no limit on how many times the Gift Tax Exclusion can be used as long as they are spread around to different people. For instance, a father could give $14,000 to his son and another $14,000 to his daughter and avoid federal taxes on a total of $28,000. There is also an unlimited marital deduction for gifts given to a spouse, but in general, this may be less useful assuming joint ownership of property.
There are additional ways to take advantage of the Gift Tax Exclusion to give tax-free gifts. For instance, a married couple can make use of a technique called "gift splitting" to both make a $14,000 tax-exempt gift to a single person, for a total of $28,000 in tax-free gifts. Gifts made for tuition or medical expenses are another way to avoid federal taxes, and may be used in addition to the standard $14,000 exclusion. Gifts made for tuition may be made regardless of relationship to the person receiving the gift, as long as it applies directly to tuition, but may not apply to any other costs related to education. A little-known facet of the tuition exclusion is that it applies to tuition for any qualifying "educational institution", including primary, secondary, and preparatory schools.
Using a gift to pay for someone's medical bills?
According to section 2503(e) of the Internal Revenue Code there are also unlimited gift-tax exclusions on payments directly to a provider for medical expenses. This includes payments for medical insurance or medical bills. So if you are looking to gift money to someone, look first to see if they have medical expenses they need taken care of. We advise not to use up your gift tax exemption when you don't need to.
If I give more than $14,000 per year do I have to pay gift taxes?
Probably not. Unless you gave some large gifts. This is a most common question and source of misunderstanding. Giving in excess of $14,000 usually does not trigger a tax. You only have to pay taxes if your total lifetime gifts exceed $5.45 million (few people hit this threshold and those who might, well, there are ways around it).
But if you do give say $200,000 your favorite nephew, then you would have to file a gift tax return. There is no gift tax that will be due, unless you have given out millions, previously to your nephew or anyone else.
Unlimited gifts to spouses, as long as they are also US-persons
You can gift to your spouse as much as you want. However, if your spouse is a non-US person, which is common for our US clients living overseas, then the spousal gift exemption does not apply.
What about gifts or inheritances from overseas, from foreign non-US persons?
Neither the grantors, the person gifting the money, nor the person receiving the money have any IRS tax due. However, a Form 3520 is required to be filed. Failure to file a Form 3520 can have horrible consequences as the penalties are rather severe.