Everything You Should Know About Giving Gifts and Avoiding Taxes
Aunt Edna just sent her favorite niece a check for $15,000. Does the niece owe taxes on this money?
No, but Aunt Edna might.
Welcome to the wacky world of gift taxes. To determine whether taxes are due, what kind of taxes are due and who owes them, you must examine the item given and the relationship between the donor and the recipient. The following three scenarios cover just about every situation you might encounter.
Scenario #1: Gifts of Cash and Cash Equivalents
Let's get back to Aunt Edna and her niece. The niece pays no tax of any kind; all she needs to do is cash the check and "party."
But Aunt Edna has a problem. The tax law for 2012 says you can only give away $13,000 to any one person in any one year and $5,000,000 over your lifetime; gifts above this amount are subject to the gift tax. Since Aunt Edna gave her niece $15,000, Aunt Edna could be required to pay gift taxes on $2,000. How much is the gift tax? It's a maximum of 35%.
As onerous as the $13,000 per-person per-year limit might seem, it's not as restrictive as it first appears.
Take a married couple with three married children and five grandchildren. On December 31, Grandma can give $13,000 to each of her three children ($39,000), to each of her children's spouses (another $39,000), and to each grandchild ($65,000). That's $143,000. And granddad can do the same thing, for total annual gifts of $286,000 — all without incurring any gift taxes. On January 1, they can do it again. Thus, this family can transfer $572,000 to the kids in a remarkably short period of time. This, in turn, can be a big help if your goal is to reduce the value of your estate for estate tax purposes (which is the most common reason people make large repetitive gifts to family members).
Of course, making gifts to all these people might not be a good idea. If a divorce occurs, for example, the grandparents could discover that they've given perhaps $156,000 to an ex-in-law and five children they may never see again. Think carefully before using this strategy.
Scenario #2: Gifts of Non-Cash Items
Would things be different if Aunt Edna gave her niece a car instead of cash?
No! If the value of the item is greater than $13,000, you're creating a gift tax problem.
Scenario #3: Gifts of Capital Assets
Would things be different if Aunt Edna gave her niece stock worth $15,000?
Yes! It gets worse!
Not only would the gift tax issue remain, a new tax would also be under consideration: the capital gains tax. Aunt Edna will pay a capital gains tax (or declare a capital loss) when she sells her stock. If there is a gain, she avoids this tax if she gives the stock to her niece instead — which is a very nice tax break for her.
But not for her niece. When you give away stock that has grown in value, the recipient of your stock receives your cost basis too — meaning the niece, in this example, will pay the capital gains tax when she sells the stock, and the tax will be based on the price Aunt Edna paid for the stock.
This obviously closes another tax loophole. There's no way to avoid the tax merely by giving the stock away: Either Aunt Edna sells the stock and pays the capital gains tax, or she gives the stock to the niece, who sells it and pays the tax. Either way, someone is going to pay the tax, and the IRS doesn't really care who it is.
The only way to completely avoid the capital gains tax is to die (admittedly, a little extreme) or give the stock to a charity.
If Aunt Edna's capital gains tax bracket is higher than her niece's, it would make sense for her to give the stock to the niece and let the niece pay the tax. If the niece is in a higher bracket, the opposite would be true: Let Edna sell the stock, pay the tax, and give the net proceeds to her niece. Clearly, open conversation is needed before the gift or sale of stock is made.
Neither Edelman Financial Services (EFS) nor its affiliates offer tax advice. Information regarding tax matters which may be provided by EFS is of a general nature only, and is not to be construed as constituting specific advice. Such information can be provided only by a tax professional and EFS recommends that individuals consult a tax professional for advice concerning tax issues.