Do You Pay Taxes on Gifts From Parents?

Tax regulations, particularly those governing gifts, are designed to ensure a fair and consistent flow of revenue to the government. From this perspective, it's logical and practical. If there weren't any guidelines around gifting, it's conceivable that families would continually transfer all their assets to the next generation, thereby bypassing potential tax liabilities. This could lead to a significant decrease in tax revenue, which could impact governmental functions and services. To prevent this, amounts exceeding a predefined gift limit are required to be reported via an annual gift tax form, as outlined in a recent article from My Edmonds News, “Excess gift giving could cause a tax surprise.” This regulatory process ensures that asset transfers exceeding the permitted threshold are accurately tracked and, if necessary, taxed. Who pays the gift tax?

In the year 2023, the rules specify that any individual can gift up to $17,000 to another individual within that calendar year without having to deal with gift tax filing requirements. If you're a part of a married couple, this limit doubles to allow a cumulative gift of up to $34,000 per individual recipient. It's worth noting that this is a per-recipient limit, which means you can give this amount to multiple individuals without triggering the gift tax.

However, the rules differ slightly if spouses are not U.S. citizens, and it's advisable to consult a tax professional or attorney to understand these variations fully.

Should your generosity prompt you to exceed these annual gift limits, be prepared to contend with potential gift tax reporting requirements. It's crucial to know that the gift tax is presently unified with the estate tax, and the maximum applicable rate stands at 40%. It's the giver of the gift, not the recipient, who is typically responsible for paying any resulting tax. When you find that your annual gift-giving exceeds the yearly limit, you'll need to file a gift tax form concurrently when submitting your individual tax returns.

It's also essential to understand that any surplus gift amounts are deducted against your lifetime unified credit. The unified credit is a lifetime limit that's available to each taxpayer and provides a buffer against both gift and estate taxes. As long as the total value of your lifetime gifts doesn't surpass this credit, you may not be obligated to pay any additional tax.

However, the unified credit has its limitations, and substantial lifetime gifting can ultimately reduce the amount available for shielding your estate from estate tax upon death. Therefore, it's crucial to approach gift-giving with a comprehensive understanding of the tax implications and how it might affect your overall estate plan. In these matters, the advice of a tax professional or estate planning attorney can prove invaluable.

When could you face a gift tax problem?

College gifting. To avoid a gift tax problem, pay tuition directly to the college since this form of payment can be excluded from the annual gift-giving limit as long as the funds are directed to be used solely for tuition. Have a conversation with the financial office to ensure you can document this. Funds for other expenses, like books, room, or board, will be considered gifts.

Funding 529 plans. Deposits into 529 accounts are considered gifts subject to annual gift-giving limits.

Medical expenses. It’s a great kindness to help a loved one with medical bills, which add up quickly. However, if you give money to the individual directly, you’ll create a gift tax obligation. Make payments directly to the health care provider for medical services on behalf of the patient.

Gifts to help with a down payment on a home. This can get tricky on several levels. Mortgage lenders look for recent deposits in bank accounts and will ask prospective buyers to substantiate the source of funds. In some cases, gifts may make the buyers ineligible for the mortgage. If the buyer says the funds are a gift, it may create a gift tax obligation to the donor.

Gift of real estate. If the owner gives the property to a relative for little or nothing in return, they must file a gift tax form – assuming the value exceeds the annual exclusion.

Remember, if you give a lump sum for the maximum amount to any one individual, you may not give them any additional gifts without triggering the need to pay a gift tax. For example, you gift a grandchild a lump sum of $17,000 for college expenses, then send the family on vacation and provide generous birthday gifts. Combining these gifts is more than the annual limit and will present a gift tax event.

The IRS is paying attention to the massive non-compliance in the timely filing of the annual gift tax form, so be careful while you are being generous.

Reference: My Edmonds News (May 22, 2023) “Excess gift giving could cause a tax surprise”