Everything You Need to Know About Gift Taxes

Hello, readers! Welcome back to the Hoods Tax & Accounting blog! If this is your first time here, welcome! We’re delighted to be able to share up-to-date information about taxes, bookkeeping, and accounting. Our blog is also dedicated to educating you about tax-advantaged savings accounts, tax provisions, programs, and more! We aim to provide you with the tools needed to meet your short and long-term goals. Our seasoned professionals are experts on the tax code, eligible deductions, and QuickBooks—all necessary fundamentals for saving you money! The Hoods Family has been around since 1988 and our comprehensive accounting and tax planning services are among the best in the Lowcountry. If you’re in need of tax preparation, accounting, QuickBooks training, or business consulting services, do not hesitate to schedule an initial consultation! As we approach the end of the year, tax season steadily approaches. We recommend preparing early to maximize your savings and refund. We do offer contactless services using a combination of over-the-phone consultations and digital drop-offs, for safety and convenience. You can read more about our hours and submit a request for a meeting using our website!
 
Our last article was a culmination of our Basics of accounting series. In part one, we discussed why accounting is a primary function in the management of a business of any size. We detailed what exactly accountants are responsible for, as well as how they execute these responsibilities. Like bookkeeping, accounting is separated into distinct types. We provided an overview of the differences between these types and how to determine which type is suitable for your business. In addition to answering a few common questions about accounting, we shone a light on the benefits of hiring a professional accountant. In part two, we started parsing through the nitty-gritty details of accounting principles. Accounting principles are the general guidelines by which accountants perform their duties; and each principle is underpinned by a practicality. While the most commonly recognized accounting principle is the accrual principle, in part two of this series we covered the consistency principle, the full disclosure principle, the conservatism principle, and more. In part three, we continued our discussion on accounting principles, then finished out the series by answering a couple of questions and providing a few best practices for accurate accounting. The aim of the Basics of Accounting series was to provide a solid foundation for understanding how accounting works and to stimulate an interest in further learning. If you haven’t already, make sure to give this series a read! 
 
Today, in honor of the season of giving, we’d like to provide you with a comprehensive explanation of gift taxes. Many aren’t aware gift taxes exist and, if you’ve never heard of them before, don’t worry. There’s no tax on a majority of gifts you’ll be giving this holiday season. In fact, the gift tax only applies to gifts of a certain value, and this value is determined by the IRS. In our discussion of the gift tax, we’d like to give you a basis for why such a tax exists by exploring its formation and history. As well, we’ll make sure you know how to pay your requisite dues whenever you give a gift to someone (or someone gives a gift to you)! 
 
The History of the Gift Tax
 
First, let’s define what a gift is. While this may seem obvious, the definition according to the IRS is the one we’ll be referring to today. According to the Internal Revenue Service, 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.” Now, a taxable gift can come in the form of cash, stocks, real estate, or intangible property (such as intellectual property, trademarks, patents, or copyrights), and is considered “completely gratuitous” when there is nothing of value exchanged. Gift can also be “gratuitous in part,” and this occurs when some amount of value is exchanged, but not the full amount given. In this case, the difference between the amount given and the amount received is the gift. 
 
The gift tax wasn’t even a thing until 1924, when—in response to people attempting to escape paying their taxes—the IRS cracked down. Even then, the tax was repealed in 1926. Four years later, in 1932, the entire idea was overhauled and reintroduced. The manner by which the gift tax disallows individuals to escape paying their taxes is difficult to grasp unless you first understand the estate tax. The estate tax has seen much debate in the decades since its inception. Essentially, your estate is the combined value of all of your assets. When you die, before these assets are bequeathed to your heirs, they are taxed a percentage. Now, imagine you have $100 million dollars. Instead of assigning this amount to your heirs in your will and having to pay a chuck to the IRS, you once might’ve been able to gift portions of your estate to those of your choosing while still alive and—in this way—circumvent the estate tax. Just as you wouldn’t be taxed for gifting your money, the recipients wouldn’t have to pay income taxes either. That is, until the invention of the gift tax. 
 
At first, the gift tax was only implemented as a means of minimizing estate and income tax avoidance. Soon enough, however, it became clear the gift tax could be used to raise revenue (with $4.6 billion being garnered by the gift tax in 1999 alone). The gift tax still exists today. Why haven’t you ever had to pay the gift tax? Well, the gift tax has an exemption, which we’ll discuss in the next part. 
 
The Gift Tax as of 2021
 
Most people never have to worry about paying the gift tax because the annual exclusion amount is around $15,000. This means that you can gift up to $15,000 in value to as many people as you want and you won’t have to file a gift tax return. Now, in an individual’s lifetime, the exclusion amount is $11.7 million, which means you can give up to $11.7 million over the course of your life without paying gift tax. If you exceed the exclusion amount, you’ll still only owe taxes on the amount over $15,000. For example, if you gave $30,000 to seven friends this year, you would owe gift taxes on $105,000 (which is thirty-thousand dollars minus fifteen-thousand dollars times seven). 
 
This might be frightening upon first glance and make you fearful of accepting large gifts, but there’s no reason to worry. The gift tax is paid by the gifter, not the recipient. As well, certain gifts are not considered taxable at all. The gift evidenced in the example above is one, and that is considered a “present interest gift,” which means the gift can be enjoyed as soon as it’s received. Then there are charitable gifts, such as those you might make to a non-profit organization. Then there are gifts made to a spouse who is a U.S. citizen. Finally, there are gifts which are for educational expenses. These educational gifts are defined quite narrowly, in that only payments made directly to educational institutions for the purpose of tuition qualify. 
 
Outright cash isn’t the only type of gift recognized by the IRS, which is where some people find themselves tripped up. If you cancel someone’s debt, this is considered a gift. If this gift exceeds the annual exclusion, you’ll need to pay the gift tax. Likewise if you make payments which are owed by someone else. There are several other instances where you might have to pay the IRS for a transaction which they consider to be a gift. Keep in mind, gifts to minors are not exempt from the gift tax. 
 
Advantages and Disadvantages
 
Now, regardless of the advantages or disadvantages of paying the gift tax, it’s required by law. Therefore, you should never attempt to find a way “around” paying the gift tax (no matter what articles you may read encouraging doing so). Using the gift tax to break up your estate can result in reduced estate tax, which is a concern for those with millions of dollars to lose upon their death. There is a tax basis, as well, which can lower the amount of income taxes paid on a piece of property which has appreciated over one person’s lifetime. However, exercising the gift tax will mean lessening your net worth. 
 
How to File
 
To file your gift taxes, you’ll need to file a Form 709: U.S. Gift (and Generation-Skipping Transfer) tax return. You’ll only file this if you exceed the annual exclusion amount for said tax year. 
 
 
We hope you’ve enjoyed learning about the gift tax! As we approach the next tax season, consider Hoods for your accounting needs! We offer bookkeeping, accounting, and business consulting services. As well, we offer tax preparation, payroll, and QuickBooks training! If you have any questions or are interested in a consultation, do not hesitate to reach out. We do offer virtual consultations over Zoom, as part of our effort to accommodate everyone in these trying times. We look forward to hearing from you! Thank you for taking the time to read our Basics of Accounting series and we hope you’ll return for future learning! Until next time!