Gifts are not taxable income. However, they can come back to haunt you! Be aware of the three ghosts of gift tax.
The first ghost will come if you are applying for a mortgage and the
bank is trying to determine where you’re getting the money for your down
payment. They want to make sure you’re not taking out a side loan (and
are hence a worse risk to them because of your greater debt burden). If
you are going to use gift money to buy a house, they will want a letter
from the donor stating it’s a gift and not a loan.
The second ghost will come wanting evidence of a gift to prove that it
is not taxable income. Once I had a self-employed person get audited by
the IRS. The first thing the IRS does with a self-employed person’s
audit is add up all the deposits into their bank accounts to see if it’s
more than the income they claimed. The IRS came back and said his
deposits into his bank account were $8,000 more than he showed on
Schedule C. In fact, they said, he’d left off all his August income. He
claimed he didn’t even work that August! Curious, I asked why he hadn’t
worked. He said it was because he’d gotten married. Aha! Those deposits
were wedding gifts, not subject to income taxes! Happily, we could prove
he’d really been married then, and that a large deposit went to pay for
the wedding—it really was from his parents.
The third gift tax ghost comes for the paperwork, which can be a bit
complex. The first thing to know is that you don’t have to do anything
if the gift was less than some “de minimis” annual exclusion. De minimis
literally means “so little we can disregard it.” The annual exclusion
was $10,000 for many, many years, and started to climb with inflation a
few years back. For 2018 it’s $15,000 per recipient. So, you can give
$15,000 to your daughter and $15,000 to your son and $15,000 to your
son-in-law and $15,000 to your daughter-in-law… and if you’re married
your spouse can do the same thing. That’s $15,000 all-in, including
Christmas presents (there are some exceptions surrounding payments made
directly to a hospital or college).
If you get a gift of whatever amount, it’s all
cool. Make a note in your checkbook, maybe copy the check for your tax
files, and send a thank you note (I didn’t have to tell you that, I’m
sure). You can stop reading here. Fa la la la, enjoy your day!
The problem is if you give a gift over the
annual exclusion rate. Now you have wandered into the territory of
estate taxes—the tax you pay when you transfer money from one generation
to another.
Here’s how it works.
Imagine you’ve got a net worth of $12,000,000 and you’re feeling a bit
peaked. Imagine also that you know that the estate tax exemption happens
to be $11,180,000 right now. You gather your two beloved children to
your bedside and say “here, each of you, have $1,000,000 each.” You
bring your net worth down to $10,000,000 and then die the next day. Did
you cheat the tax man? No! Because gifts over the annual exclusion
amount get added back to your estate transfer] tax return.
In fact, all the gifts you made in your entire lifetime above the “de
minimis” amount get added back to your estate tax return. Depending on
the estate tax exclusion level in the year you die, the gifts you gave
may or may not cause you to have to pay any actual tax, but all the
gifts you ever made eat away at a lifetime exclusion that isn’t actually
knowable until the day you die; estate tax exclusions shift around a
lot depending on who’s in control of Congress.
How do gifts you made in 1997 get added to your estate transfer return
when you die in 2047? Paperwork! Really dreadful paper-work that
literally follows you to the grave. When you give a gift over [whatever
the annual exclusion is that year], you must file a gift tax return and
tuck it into a folder called “Estate of [Your Own Name]”. It’s not a
hard return to do, but you’ll probably pay an accountant a couple of
hundred dollars to do it, and you’ll be stuck with a folder in your
filing cabinet that your heirs/accountants/lawyers should know about
when you die.
There you have it: give gifts of above $15,000 a year per per-son per
recipient and you’re saddled with serious paperwork requirements. It’s
not (usually) a tax, but it’s taxing nonetheless. If the ghosts of gift
tax come for you this year, you can be ready for them.
Source: Wendy Marsden, CFP®, CPA, MS, Greenfield, MA