If there is a gift tax, is everyone breaking the law when they receive holiday and birthday gifts without reporting them to the Internal Revenue Service?
Technically speaking, gifts are subject to taxation, but you need some background information to understand the situation.
Federal Estate Tax
It all starts out with the existence of the federal estate tax that was enacted in 1916. Shortly after its passage, people started giving gifts to their loved ones to avoid the tax. Pro-tax legislators enacted a gift tax in 1924 to close the loophole, but it was repealed in 1926.
In 1934, it was reenacted, and it has been in place since then. The gift tax and the estate tax were unified under the tax code during the 1970s. There is a unified gift and estate tax exclusion that allows you to transfer a certain amount before the taxes would kick in.
You don’t have to pay taxes on gifts that you receive during your life because of the existence of the exclusion, which is considerable at $12.06 million this year. There are annual adjustments to account for inflation, so you will see relatively slight increases in this figure as the years pass.
We should point out the fact that there is a marital gift and estate tax deduction. If you are legally married to an American citizen, the tax code allows for unlimited transfers between you and your spouse free of taxation.
Additional Gift Tax Exemptions
The unified gift and estate tax exclusion is not the only exemption that can be utilized to transfer assets in a tax-free manner. There is also a $16,000 per person, per year gift tax exemption that you can use to transfer this amount to any number of people within a calendar year tax-free.
This exemption sits completely apart from the unified lifetime exclusion, so you could give $16,000 to an unlimited number of people during a given year and you would not be using any of your multi-million dollar unified exclusion.
If you are exposed to the federal estate tax, you could use this exclusion to transfer assets tax-free while you simultaneously reduce the taxable value of your estate.
Direct gift giving is an option, and you can also use this exclusion to fund certain types of trusts. It could also be utilized in conjunction with transfers among members of a family limited partnership.
Another way that you can assist others financially without being taxed for your generosity is to pay school tuition for students. The payments must be made directly to the institutions, and this is a tuition only exemption that does not extend to books, fees, and living expenses.
Of course, you could use your $16,000 per person annual exclusion to add additional support. It should be noted that a married couple could combine their respective exclusions and give $30,000 to any number of people annually.
The last gift tax exemption allows you to pay medical bills for others. There is no limit to the amount that you can cover, and this extends to the payment of health care insurance premiums.
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