Expert Tax Tips: Are Gifts and Inheritances Tax Deductible?

gifts and inheritances tax deductible

This article is accurate for returns filed through tax year 2017. Under the Tax Cuts and Jobs Act, some of the laws mentioned changed beginning in 2018. Learn more about the updated tax laws enacted under the Tax Cuts and Jobs Act here.

Receiving a monetary gift is a wonderful opportunity to improve your financial standing. It may give you the opportunity to pay off some old debts, improve your home, or just add to your savings for a later date. Whatever the case, these types of gifts are sure to be well-received, and they can take some of the stress out of your financial life.

With that said, you always have to bear taxes in mind. When you receive an inheritance or a financial gift—or when you give one, for that matter—you need to think about the tax implications. As you may already know, there is a gift tax in place in the United States, which governs the way “free” money moves from one party to another. Fortunately, the gift tax is relatively simple, and it does not actually affect that many people in the end.

Let’s take a closer look at some of the key points related to the gift tax.

Who Pays?

The first thing to understand about the gift tax is that it is paid, when applicable, by the giver. So, as the recipient of a monetary gift, you do not need to worry about the gift tax form or anything else related to this topic. Great news, right? The money is yours to do with what you wish, and there will be no tax implications on your end.

For the party giving the financial gift, the tax implications depend on the amount of money in question. In 2017, the amount you can give away before having to think about taxes is $14,000 per person. That means you may give away up to $14,000 to as many individuals as you would like without even needing to report the giving on your tax return.

It is worth noting that the $14,000 exclusion is based on each individual person, so you may be able to go higher than that without any issues. For example, if you are married, both you and your spouse can give $14,000, meaning you could combine to give one person up to $28,000 without any tax effects.

The Lifetime Exclusion

So, if you give someone else more than $14,000 within a single year, you have to pay taxes on that gift, right? Not so fast. In addition to the yearly exclusion of $14,000 per individual, there is also a lifetime exclusion to consider.

As of 2017, that exclusion is at $5.49 million. That’s right, million. Unless you have given away at least $5.5 million in your lifetime, you will not have to worry about a tax liability based on your gifts.

Each time you give a gift which exceeds the annual exemption, the amount you go over the annual exemption is deducted from your lifetime exemption. Let’s walk through a quick example to make sure this topic is clear.

  • In 2017, you decided to give someone a gift of $30,000. You are single, and you gave the gift to just one individual, so this gift exceeded the annual exemption by $16,000.
  • When filing your 2017 tax return, you will need to report this gift to the IRS, since it exceeded the annual gift tax exclusion. We will have more information on reporting gifts later in the article.
  • As a result of going $16,000 over the annual exclusion, your lifetime exclusion will be reduced by that $16,000 figure. Of course, this is not going to make much of a dent—you started with an exclusion of $5.49 million.
  • Moving forward, gifts that you give in future years—gifts which exceed the annual exclusion—will continue to come off your lifetime exclusion number. Only when you have completely exhausted the lifetime exclusion will you then be required to pay tax on future gifts.

As you can see, the vast majority of people will not need to worry about paying the gift tax. Unless you plan to give away many millions of dollars, you won’t be liable for any additional tax at the end of the year. However, even if you don’t expect to reach the lifetime exclusion number, you still need to report gifts that do exceed the annual exclusion.

Estate Tax Issues

While the gift tax and the estate tax (or inheritance tax) are different things, they are connected in the tax code. Gifts which reduce your lifetime exemption will also reduce your inheritance tax exemption. If you have a large estate which will be passed on when you are deceased, more of that estate may be taxed if you have used up part of your exclusion through the giving of gifts.

As may be obvious at this point, one way to reduce the amount of tax that is paid on your estate is through the giving of annual gifts which come in below the exemption number. For instance, if you paid out annual $14,000 gifts to your children, that money would be given tax-free and would have no impact on any taxes owed by your estate.

Not All Gifts are Taxable

In some cases, you will be able to give gifts which are larger than the annual tax exclusion with no implications on your return. Certain gifts are considered to be tax-exempt, meaning not only will you pay no taxes on the gift, but you won’t even need to report the gift at the end of the year.

For one, you can give gifts to your spouse without any tax issues. Also, you are able to give to charities, as long as those charities are approved by the IRS. Other examples include gifts to pay for someone else’s medical expenses, or to pay someone’s tuition. It should be noted that these are just a few examples, so you will want to research the tax status of other kinds of gifts you may decide to give.

The Paperwork

Should you happen to exceed the $14,000 annual exclusion, you will need to report your gift to the IRS (assuming it is not a tax-exempt gift, as mentioned above). To do so, you will need to use Form 709. Again, it is necessary to file this form even if you aren’t going to have to actually pay any taxes for the year. The deadline for filing Form 709 is the same as the deadline for filing your 1040 tax return.

We hope the gift tax definition we have laid out in the article helped you to understand this topic. As we have shown, most people will not need to worry about paying taxes on gifts, as many millions need to be given away before tax will be owed. If you do surpass that mark, you can expect to pay a gift tax rate which mirrors the rate you pay on individual taxes.

So, in the end, are gifts taxable? While the answer is technically yes, the taxation is not a concern for the vast majority of the population. As long as you understand the rules and file the appropriate paperwork when necessary, you should be able to give monetary gifts with little concern for tax implications.

And, of course, if you are a gift receiver, the news is even better. There are no tax implications for you, so enjoy!

This article is intended to provide general information to the public and does not provide personalized tax, investment, legal, or business advice. You should seek the assistance of a professional for advice on taxes, investments, and any other financial, legal, or business matter pertinent to your individual situation.