The Federal Gift Tax: What Is It and How Does It Work?

Oct 06, 2022 By Triston Martin

Gifts of significant monetary value given from one individual to another are subject to the gift tax imposed by the federal government. It is not intended to restrict the giving of presents daily. The person who gives a gift is responsible for paying the gift tax; the person who receives the gift is not subject to this tax. This tax aims to prevent individuals from evading estate taxes after they pass away. In addition, it does not apply to all the donations given during the donor's lifetime.

People have the right to give away money or property in amounts that are considered to be relatively little. The gift tax does not apply to small monetary gifts, such as sending a check to your grandchildren for a few hundred dollars or even a few thousand dollars. The gift tax is not triggered in the same way if, for example, you pay for a friend or family to accompany you on a vacation that you are taking.

Because they are an exception to the norm, some presents may be given, particularly those of a much higher value. Instead, the gift tax only applies to thousands of dollars or more of significant financial contributions. These may take the form of monetary presents or objects that, on their own, would require a significant investment, such as a brand-new automobile or a home.

What Counts As a Gift for Tax Purposes?

Figuring out what does and does not qualify as a gift for a tax deduction may be challenging. Three things determine whether or not a gift is taxable:

  • Who is going to get it?
  • Its reasonable market value
  • No matter if it was a gift with a current interest or a gift with a future interest

The Person Who Will Be Receiving the Gift

If the recipient is a member of an exempt category, then you are not required to pay taxes on any gifts that you provide to that person. When it comes to specific people, this depends on their connection to you. Regarding organizations this is determined by the organization's tax status. If you and your partner are citizens of the United States, then the federal gift tax does not apply to any presents you give to one another. Because of the federal unlimited marital deduction, married couples can transfer property to one another without incurring tax consequences, either during life or after death.

Even though regulations are in place, donations to charitable organizations that meet specific criteria and political groups are not taxable. For instance, contributions given to political groups are required to be used only by such organizations.

While presents to one's spouse are free from taxation, presents to one's children, grandkids, or other relatives or friends are not exempt from taxation. The only two categories exempt from this restriction are medical expenditures and educational costs. There is no upper limit on how much you may contribute to another person's medical expenses or educational expenses, and you won't be subject to any gift taxes as a result.

Fair Market Value

When presented in monetary form, a gift's worth is immediately apparent. If you offer someone $10,000 and expect nothing in return, you have completed a gift worth $10,000. However, if you sell a property worth $300,000 to someone for just $150,000, you will be judged to have given them a gift of $150,000. This is because you were not given anything in return for the other half of the property's worth, which equals $150,000.

Present Interest vs. Future Interest

One definition of a present-interest gift is one that the receiver can put to immediate use, enjoy, and profit from. There are no conditions tied to it in any way. If the receiver isn't able to make full use of the present or fully appreciate it until some point in the future, we call it a gift with future interest. This is a crucial point of differentiation.

Donating money to establish a trust or reserving a life estate in real estate are two typical instances of contributions with future interests. Your beneficiary won't normally become the only fully vested owner until after you've passed away, regardless of the circumstances. Gifts of future interests are considered taxable transfers and must be reported to the Internal Revenue Service (IRS) on Form 709, the United States Gift.

Related Articles