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Navigating exclusions and exemptions: the federal gift and estate tax

Let’s start with a hypothetical scenario: 2014 was a good year for you, and with gas prices dropping ever lower you’ve decided to replace your energy efficient hybrid car with another, more luxurious model. Your only grandson, who is paying off college debt, drives a gas guzzling SUV. To help him save money you give him the hybrid, a 2011 model which the Kelley Blue Book values at $16,000.

Next thing you know, tax season comes up, and in a conversation with some friends you learn that you will have to declare the gift, or at least part of it, to the IRS. You’re aghast, but your friends are right: If, over the course of the year, your gift to a single person exceeds a value of $14,000 you must inform the federal tax authority by filing an IRS Form 709 before April 15 alongside your personal income tax return. Gifts valued at less than $14,000 — the number denotes the annual gift tax exclusion for the years 2013-15 — need not be declared. Moreover, you may make gifts under $14,000 to as many different recipients as you wish.

But back to your grandson and the hybrid car: Does the fact that you need to file a gift tax return mean you will owe taxes? The short answer is probably not. The long answer? Aside from the annual gift tax exclusion there is another IRS limit to factor in, the lifetime personal exemption from gift and estate taxes. Setting a limit for the total value of gifts you may make tax free over the course of your lifetime, this exemption which rises annually with inflation is $5.43 million for 2015. (Last year the limit was $5.34 million.)

And how do the annual gift tax exclusion and the lifetime gift and estate tax exemption relate to each other? Anytime you make a gift with a value of more than $14,000, the surplus amount will count against the lifetime exemption. In the case of your gifted car, you will have to deduct $2,000 from the (currently) $5.43 million, and once you’ve reached this limit (or, rather, the future inflation-indexed limit) you’ll have to pay gift and estate taxes.

by Kevin J. Moore