When does the Gift Tax Apply?

A gift tax is a tax imposed on the transfer of ownership of property during the giver’s life. The United States Internal Revenue Service says that a gift is “Any transfer to an individual, either directly or indirectly, where full compensation (measured in money or money’s worth) is not received in return.”

Who is liable for the Gift Tax?

When a taxable gift in the form of cash, stocks, real estate, or other tangible or intangible property is made, the tax is usually imposed on the donor (the giver) unless there is a retention of an interest which delays completion of the gift. A transfer is “completely gratuitous” when the donor receives nothing of value in exchange for the given property. A transfer is “gratuitous in part” when the donor receives some value but the value of the property received by the donor is substantially less than the value of the property given by the donor. In this case, the amount of the gift is the difference.

US Gift Tax Law

In the United States, the gift tax is governed by Chapter 12, Subtitle B of the Internal Revenue Code. The tax is imposed by section 2501 of the Code.

For the purposes of whether or not a ‘gift’ is taxable income, courts have defined a “gift” as the proceeds from a “detached and disinterested generosity.” Gifts are often given out of “affection, respect, admiration, charity or like impulses.”

Estate Tax Effect of Gifts

Generally, if an interest in property is transferred during the giver’s lifetime (often called an inter vivos gift), then the gift or transfer would not be subject to the estate tax because it would not be owned by the Donor when they die. In 1976, Congress unified the gift and estate tax regimes, thereby limiting the giver’s ability to circumvent the estate tax by giving during his or her lifetime. Some differences between estate and gift taxes remain, such as the effective tax rate, the amount of the credit available against tax, and the basis of the received property.

There are also types of gifts which will be included in a person’s estate, such as certain gifts made within the three-year window before death and gifts in which the donor retains an interest such as gifts of remainder interests that are not either qualified remainder trusts or charitable remainder trusts. The remainder interest gift tax rules impose the tax on the transfer of the entire value of the trust by assigning a zero value to the interest retained by the donor.

Non-taxable gifts

Generally, the following gifts are not taxable gifts:

  • Gifts that are not more than the annual exclusion for the calendar year (last raised to $15,000 per recipient for any one donor, beginning for 2018)
  • Gifts to a political organization for its use
  • Gifts to charities
  • Gifts to one’s (US Citizen) spouse (non taxable because of something called the gift tax marital deduction)
  • Tuition or medical expenses one pays directly to a medical or educational institution for someone. Donor must pay the expense directly. If donor writes a check to donee and donee then pays the expense, the gift may be subject to tax.

Exemptions

There are two levels of exemption from the gift tax.

          Annual Exclusion

First, gifts of up to the annual exclusion ( $15,000 for 2018 thru 2020) incur no tax or filing requirement.

Gift Splitting by Spouses

By splitting their gifts, married couples can give up to twice this amount tax-free. Each giver and recipient pair has its own annual exclusion; a giver can give to any number of recipients and the exclusion is not affected by other gifts that recipient may have received from other givers.

Lifetime Exemption for taxable gifts and estates

Second, gifts in excess of the annual exclusion may still be tax-free up to the lifetime estate basic exclusion amount ($11.58 million for 2020). For estates over that amount, however, such gifts might result in an increase in estate taxes. Taxpayers that expect to have a taxable estate may sometimes prefer to pay gift taxes as they occur, rather than saving them up as part of the estate because gift taxes reduce the size of the taxable estate if paid more than 3 years prior to death, and also because lifetime gifts can shift future appreciation in value out of the estate for estate tax purposes.

Generation Skipping Transfer Taxes

Beware of the GST when doing gifting. Exemptions to some extent can apply. Careful planning and reporting is crucial.

Non Residents

For gift tax purposes, the test is different in determining who is a non-resident alien, compared to the one for income tax purposes (the inquiry centers around the decedent’s domicile). This is a subjective test that looks primarily at intent. The test considers factors such as the length of stay in the United States; frequency of travel, size, and cost of home in the United States; location of family; participation in community activities; participation in U.S. business and ownership of assets in the United States; and voting. It is possible for a foreign citizen to be considered a U.S. resident for income tax purposes but not for gift tax purposes.

If a person is a non-resident alien for purposes of gift tax, taxation of gifts is determined in a different way. If the property is not located in the U.S., there is no gift tax. If it is intangible property, such as shares in U.S. corporations and interests in partnerships or LLCs, there is no gift tax.

Non-resident alien donors are allowed the same annual gift tax exclusion as other taxpayers . Non-resident alien donors do not have a lifetime unified credit. Non-resident alien donors are subject to the same rate schedule for gift taxes.

U.S. citizens and residents must report gifts from a non-resident alien that are in excess of $100,000 on Form 3520.

Noncitizen spouse

According to 26 USC section 2523(i), gifts to a non-U.S.-citizen spouse are not generally exempt from gift tax. Instead, they are exempt only up to a specified amount foreseen by 26 USC section 2503 (b)

U.S. Federal gift tax contrasted with U.S. Federal income tax treatment of gifts

Pursuant to 26 USC 102(c), the receipt of a gift, bequest, devise, or inheritance is not included in gross income. Thus, a taxpayer does not include the value of the gift when filing an income tax return. Although many items might appear to be gift, courts have held the most critical factor is the transferor’s intent. The transferor must demonstrate a “detached and disinterested generosity” when giving the gift to exclude the value of the gift from the taxpayer’s gross income.The courts have defined “gift” as proceeds from a “detached and disinterested generosity.”

“Gifts” received from employers that benefit employees are not excluded from taxation. 26 U.S.C. § 102(c) clearly states employers cannot exclude as a gift anything transferred to an employee that benefits the employee. Consequently, an employer cannot “gift” an employee’s salary to avoid taxation.

Gifts from certain parties will always be taxed for U.S. Federal income tax purposes. Under Internal Revenue Code section 102(c), gifts transferred by or for an employer to, or for the benefit of, an employee cannot be excluded from the gross income of the employee for Federal income tax purposes. While there are some statutory exemptions under this rule for de minimis fringe amounts, and for achievement awards, the general rule is the employee must report a “gift” from the employer as income for Federal income tax purposes. The foundation for the preceding rule is the presumption that employers do not give employees items of value out of “detached and disinterested generosity” due to the existing employment relationship.

Under Internal Revenue Code section 102(b)(1), income subsequently derived from any property received as a gift is not excludable from the income taxed to the recipient. In addition, under Internal Revenue Code section 102(b)(2), a donor may not circumvent this requirement by giving only the income and not the property itself to the recipient. Thus, a gift of income is always income to the recipient. Permitting such an exclusion would allow the donor and the recipient to avoid paying taxes on the income received, a loophole Congress has chosen to eliminate.