Marginal tax rate:
Effective tax rate:
Capital Gains tax:
Introductory note on the Unified Credit
Each person has a certain amount that he or she can transfer over the course of his or her life and after death (by will) completely tax free. The amount of the unified credit changes, depending on the year. This means that people do not pay any tax even on taxable gifts. Instead the amount of the taxable gift comes off their unified credit Once the unified credit is depleted, then the transfers start actually being subject to taxation. For 2017, the amount of the unified credit allows lifetime tax-free gifts of up to $5,490,000.
The gift tax is imposed only on completed gratuitous transfers or transfers not made for an adequate and full consideration, in money or money’s worth. The tax is imposed whether the transfer is to a trust, whether the gift is direct or indirect and whether the property transferred is real or personal, tangible or intangible. See I.R.C. §§ 2501(a)(1), 2511. The rates start at 41% (for gifts beyond the $1,000,000 unified credit), reaching a maximum of 55%. See I.R.C. § 2001. We will discuss the rates in more detail later in the section.
In order to qualify as a gift, the transfer must give up “dominion and control” of the property, thereby leaving the donor with no power to change its disposition. See Treas. Reg. § 25.2511-2(b). The gift tax is considered “tax exclusive” because the donee receives the property, unreduced by the gift tax paid by the donor. For example:
In 2015, Veronica gave $164,000 to her daughter, Olive, as a down payment on her apartment that was just converted to a co-op. Since the gift is over the 2015 annual exclusion amount of $14,000, Veronica must file a gift tax return (Form 709) to report the transfer. Only the excess over the $14,000 annual exclusion amount ($150,000) would be considered a taxable gift. The $150,00 will be applied to Veronica's lifetime unified credit. She will only have to pay gift tax on it if her lifetime gifts exceed the unified credit amount. If the gift tax is $60,000 on this amount and Vernonica exceeds the lifetime unified credit amount, $60,000 will be applied towards Veronica's total gift tax and she will be is required to pay this amount to the IRS. The $60,000 would not be subtracted from the $164,000. Olive would still receive the full amount of the gift.
The basis of property received as a gift (for capital gains purposes when the donee later sells the property), remains the same as the donor’s basis (this is called a “carryover” basis). See I.R.C. 1015. An exception to this general rule, however, is that the donee is entitled to step up the basis by the amount of gift tax paid by the donor on the gift. For example:
EXAMPLE (1): John buys a diamond ring for $3,000. Later, John gives the ring to Christine. At the time of this transfer, the ring is worth $5,000. Two years later, Christine sells the ring for $7,000. Since Christine received the ring as a gift, she takes over the “basis” of John. Since John bought the ring for $3,000, his basis was $3,000. Thus, Christine’s basis is also $3,000. Thus, she realized a capital gain of $4,000 based on her sale of the ring for $7,000.
EXAMPLE (2): John buys a Picasso for $400,000. A year later, he gives the Picasso to Christine. At that time, it is worth $1,000,000. He pays $200,000 in gift tax on the transfer. Although Christine takes John’s basis ($400,000), she can add the $200,000 that he paid in gift tax to her basis. Thus, Christine’s basis in the property would be $600,000. Thus, if she sells it for $1,500,000, she would realize a capital gain of $900,000.
To calculate taxable gifts, the total exclusions and deductions are subtracted from the total amount of the gifts given in a calendar year.
For many years, the first $10,000 of a present interest in property transferred to a donee during the calendar year was excluded. See I.R.C. § 2503(b). This is commonly known as the “annual exclusion.” For transfers made after 1998, the annual exclusion is indexed for inflation, rounded to the next lowest multiple of $1,000. See I.R.C. § 2503(b)(2). For 2013, the annual exclusion is $14,000. For example:
EXAMPLE (1): In 2013, Stella gave her niece, Sharon, a cash gift of $8,000. She also gave her cousin, Rusty, a used car, valued at $6,500. Neither gift would be considered a taxable gift because they both are less than the $14,000 annual exclusion.
EXAMPLE (2): In 2013, Stella gave her niece, Sharon, a cash gift of $15,000. She also gave her cousin, Rusty, a new car, valued at $19,000. Only the first $14,000 of both gifts would qualify as part of the annual exclusion. The balance, $1,000 and $5,000, respectively, would be considered taxable gifts. So, Stella will have to file a gift tax return and pay taxes on the gifts (subject to the unified credit, which will be discussed later on).
A husband and wife, who are both either U.S. citizens or residents, can give up to $28,000 to the same person during a calendar year without making a taxable gift because the gift is considered to be made one-half by each. See I.R.C. § 2513. This is called gift-splitting. The election is made on a federal gift tax return (Form 709) for that year. For example:
In 2013, Stella and husband, Jonathan, each gave her niece, Sharon, a cash gift of $12,000, for a total of $24,000. Stella also gave her cousin, Rusty, a used car, valued at $6,500. Jonathan gave him his old sailboat, valued at $15,500. None of the gifts would be considered taxable gifts because Stella and Jonathan’s combined gifts to Sharon and Rusty are less than the $28,000 annual exclusion for married couples who elect to gift split.
The annual exclusion is not the only potential exclusion in the gift tax area. Another type of exclusion is tuition paid directly to a qualifying educational organization on behalf of an individual. The student can be full- or part-time. See I.R.C. §§ 170(b)(1)(A)(ii), 2503(e)(1). Any payments for items other than tuition, however, such as room and board or books, would not qualify for this exclusion. For example:
In 2017, Stella paid $29,000 in tuition to Stanford University on behalf of her niece, Sharon. In addition, Stella paid another $15,000 to the school to cover Sharon’s housing and meals. The $29,000 payment for tuition would qualify for the education exclusion, so this gift is not a taxable gift. The $15,000 payment for non tuition would not qualify for the education exclusion. However, since Stella has not given any other gifts to Sharon that year, the first $14,000 would qualify for the annual exclusion. The remaining $1,000 would be considered a taxable gift.
In addition, the direct payment of expenses for medical care, on behalf of an individual, to the person or organization providing medical services is also excludable from the gift tax. Typically, these expenses would encompass payment for doctors, hospitals, medical transportation and prescription drugs. See I.R.C. §§ 213(d), 2503(e)(2)(B). For example:
In 2017, Stella paid $18,000 directly to the hospital that provided medical treatment to her niece, Sharon, after a car accident Sharon had during her freshman year at Stanford University. The $18,000 payment for medical expenses would qualify for the medical exclusion, so this gift is not a taxable gift.
Pursuant to the Economic Recovery Tax Act of 1981, gifts made after 1981 between spouses, who are U.S. citizens, are eligible for an unlimited marital deduction. See I.R.C. § 2523(a). For spouses who are not U.S. citizens, only a limited amount ($149,000 as of 2017) of the transfer amount qualifies for the gift tax marital exclusion. The remaining balance would be considered a taxable gift and taxed the same way as other taxable gifts. For example:
Inez (French citizen) and Frederick (U.S. citizen) were married in 2007. To celebrate their ten-year anniversary, Frederick bought Inez a $250,000 diamond ring. Since Inez is not a U.S. citizen, only the first $149,000 of the ring’s value would be eligible for the gift tax exclusion. The balance would be considered a taxable gift.
An unlimited deduction is allowed for the value of property given for public, charitable and religious uses. See I.R.C. § 2522. For example:
Patricia died recently from cancer. Her will left all her assets, a total of $1,200,000 to her daughter, Lydia. Lydia is very supportive of the American Cancer Society, so she donated $25,000 to the Society, which is a qualified charity. Lydia’s donation qualifies for the charitable deduction and is not subject to gift tax. Note that Lydia’s inheritance may be subject to estate tax, however, as we will discuss later in the chapter.
Computation of gift tax
Computing the proper gift tax amount is a bit complicated, since the gift tax is cumulative over the lifetime of the taxpayer as well as progressive. The progressive rates and cumulative computation of the gift tax result in taxing larger gifts or gifts in succeeding years at higher and higher tax rates, up to the maximum rate.
Once the taxable gift amount has been calculated, there are four basic steps for computing the gift tax.
- Add the amount of all taxable gifts made by the donor in all prior periods to the current gifts.
- Determine a tax figure for all current and past taxable gifts at current rates, using the tax rates found at I.R.C. § 2001(c). (that were presumably actually paid.)
- Determine a tax figure for all past gifts without the current gifts, using the same tax rates.
- Subtract the figure calculated in Step 3 from the figure calculated in Step 2 to determine the gift tax on current gifts for the calendar year. See I.R.C. § 2502.
In computing the tax, all past taxable gifts must be accounted for, even if the donor failed to file a gift tax return.
The federal estate and gift tax law provides a single unified rate schedule for both estate and gift taxes. See I.R.C. § 2001. For 2017, the lifetime unified credit is $5,490,000.
In other words, a person may give up to $5,490,000 of taxable gifts over the course of his or her life and not pay any tax on them. But, those gifts will come off the unified credit and may expand his or her ultimate estate tax liability.