Feeling Generous? Learn Why the IRS Levies the Gift Tax and When it Doesn’t

Let’s say you’re having a good year financially, you’re single and without family obligations, and you decide to help out a nephew who is struggling to pay for his college education. You look at your various accounts, think about the appreciation of that piece of real estate that you bought two years ago, and you come up with a number; a check in the amount of $20,000, you think, would mean a lot to the young man but not really hurt you. Well, here’s the bad news: Your tax advisor will tell you that your gift, or at least part of it, will be subject to the federal gift tax.

A gift tax? It sounds counterintuitive that you should owe the IRS for being generous toward a relative, but there’s reasoning behind the law: Congress introduced the tax to keep wealthy people from avoiding the estate tax, aka death tax, by giving away all their property while they’re still living.

Fortunately, the tax comes with an exemption that most people consider substantial: For the 2015 tax year, this combined estate and gift tax exemption has been set at $5.43 million. The tax law also includes some handy exceptions, meaning gifts that will not figure into the $5.43 million. They include gifts to charity, which are always tax free; gifts to cover tuition or medical expenses, which are tax free as long as they are made directly to the institution or the provider; gifts that stay below the annual gift tax exclusion (during the 2015 tax year, you may give $14,000 tax free to as many beneficiaries as you wish); and the marital exemption (most gifts to US citizen spouses are tax free.)

Where does all this leave you and your nephew? Well, there are a couple of ways for you to be generous without the IRS stepping in. First, you can give your nephew a check for $14,000 rather than $20,000. (By the way, if you were married, you and your spouse could combine your individual annual gift tax exclusion of $14,000 each, and the full $20,000 would be tax free.) Second, you can make out a $20,000 check directly to your nephew’s college to pay for his tuition. Third, you can give your nephew the full $20,000 and file a gift tax return by April 15. In this case, the difference between the annual gift tax exclusion and your check, i.e. $6,000, will be deducted from your lifetime estate and gift tax exemption. As for your nephew — he’ll be happy no matter which route you choose.

By Kevin J. Moore

Kevin Moore, Founder of Kevin J. Moore & Associates, is focused in the areas of estate planning, trusts and probate services with additional expertise in both domestic and international business transactions and tax planning and tax controversy representation for individuals and companies.