The Federal Gift Tax

The past few weeks the federal gift tax has become an issue in a variety of contexts. The basic principle behind the gift tax is straightforward enough, although people are often surprised to hear about it.

Federal law requires the payment of a tax on the value of all lifetime gifts, subject to various exemptions and deductions. That's a loaded statement, so let's break it down and look at it.

The federal law involved is a statute. That means that Congress may change the law with the 'stroke of the legislative pen'. This has happened numerous times in the past and many observers expect it to happen again as soon as next summer.

The federal gift tax rate is currently 45% - that's right, nearly half the value of the gift. So, setting aside deductions and exemptions for the moment (discussed below), if I make a gift to my friend Jimmy of $100,000, I would then pay the IRS $45,000 for the privilege of making the gift. The entire transaction would cost me $145,000!

By the way, the donor (that's the person who makes the gift) pays the tax. The donee (the recipient of the gift) does not pay the gift tax - nor is the donee obligated to pay income tax on the gift. 'Tis better to receive, in this case!

The tax is payable on the value of the gift. With a cash gift, there's not much to worry about. If the gift is real estate, a business interest or your prize stamp collection, there is often a great deal of discussion regarding value. Added to this are a variety of valuation discounts the IRS permits under certain circumstances (such as making a gift of a small amount of stock in a corporation, where the recipient will not be in control).

Which brings us to exemptions and deductions. Like the income tax, the gift tax laws allow us to reduce the amounts otherwise payable on the tax. There are many exemptions and deductions, but the primary ones are these:

First, there is an unlimited marital deduction. So, you can give your spouse a billion dollars without owing a dime to Uncle Sam. Nice for Bill Gates.

Second, there is a charitable deduction, for certain gifts to charities. There's a lot more to say about this than will fit in one blog.

Third, there is the annual exclusion. This permits anyone to give up to $12,000 a year to any (and every) person on the planet. So, I can give my son, my uncle, my friend, my irrevocable trust, my worst enemy and that guy I don't know at all $12,000 each every year, all without paying any tax to IRS or even telling the IRS I did it. That $12,000 amount adjusts every few years (many people still remember it as a $10,000 exclusion) and it is scheduled to increase to $13,000 on January 1, 2009.

Finally, there is the lifetime exemption. This permits me to make up to $1 million in gifts during my lifetime without paying any tax. So, if I make some gifts that don't fall under any of the other deductions, I can still rely on this exemption. That's $1 million total (all my gifts over my lifetime) - not per person and not per year. In order to use this exemption, you must file a Form 709 with the IRS to let them know.

Ok, let's see if you've been paying attention. Say I want to file a quit-claim deed naming my Child as co-owner of my real Property (to avoid probate, perhaps). The Property is worth $500,000 (we'll presume there's no mortgage for this example.) What would be the result?

Well, naming my Child on the deed is a gift to my Child of half of the value of the Property. The IRS would value the gift at $250,000 (half the value of the Property), unless I could argue the property values were down, etc. - thereby requiring an appraisal. The only deductions/exemptions available are the annual exclusion and the lifetime exemption. Subtract $12,000 from the value of the gift and you have $238,000. That would be the portion of my lifetime exemption I would use to avoid paying gift tax. (Or, I could save the exemption and pay the tax, although the reasons for doing that are beyond the scope of this blog.) See, easy!

By the way, the gift tax issue is only one reason I don't recommend naming your child on the deed to your property. Liability is another reason (and there are others). Usually, there are better ways to achieve the objectives behind naming your child on the deed.

One last thought: this discussion is about the federal gift tax. Many states impose state gift taxes in addition to the federal gift tax. So, you should check with your state taxing authority on these issues. (Florida, happily, does not impose a state gift tax. One more great reason to move to Florida!)