Welcome to The Wealthy Mom MD Podcast—a podcast for women physicians who want to learn how to live a wealthy life. In this podcast, you will learn how to make money work for you, how you can have more of it, and learn the tools to empower you to live a life on purpose. Get ready to uplevel your money and your life. I'm your host, Dr. Bonnie Koo.
Hey everyone. In today's episode, I'm talking about the gift tax. I would say this topic and the Roth IRA seem to cause the most confusion. I talk about the Roth IRA in episode 14, so definitely check that one out. But today we're going to talk about the gift tax.
First of all, the name, the gift tax is actually kind of wrong in itself. But before we can get into the gift tax, we actually have to understand the estate taxes because the gift tax was created to go hand in hand with the estate tax. So let's talk about that first. And once you understand this, then the gift tax concept becomes crystal clear.
First of all, what are estate taxes? And did you even know that you may have to actually pay an estate tax? Well, I should say you won't have to pay because you'll be dead. It's your estate that will have to pay taxes. Now I'm talking specifically about federal estate taxes. The state tax level--well, that's just a whole other story that I can't get into because every state basically has different rules. So let's just talk about federal estate taxes. The good news is for most Americans, it is highly unlikely that you'll have to pay any federal estate taxes because right now in 2020, the federal estate tax exemption is $11.58 million. Meaning if your estate is under this amount, your estate won't have to pay any federal estate taxes. Now, of course, there are ways to not pay this and to sort of shelter your money if your net worth is above $11.58 million, but that's outside the scope of this episode. Okay?
What does the gift tax have to do with the estate tax limit? Basically the gift tax was created to prevent super rich people from giving away all their money in their last years of life. Because you can imagine that if you are a super rich person and let's say, you're not doing so well health wise, and you know, your days are limited. Then you're like, “Well, crap, I don't want my estate to pay taxes, so I'm just going to start giving my money away.” And so that's why the gift tax limit was created. Now, I just said that the 2020 limit federally is $11.58 million. It changes every year and it's supposed to sunset in a few years and go down to a much lower amount. The government's always changing this. That's why it's hard to give specific advice about your estate because literally the laws are always changing, but I digress.
What is the gift tax limit? It is basically the amount of money you can give away per year per person without reporting to the federal government. What do I mean by that? In 2020, the gift tax limit is $15,000 or double that if you're married, which means I can give away $15,000 to as many people as I want. So let's say I decided to be super generous and I'm giving away $15,000 to a hundred people. I won't have to file anything. The government won't care. As long as I stay under that amount per person.
What happens if I give something like 15,000.01? Not much. Let me explain. Let's say I give over literally a dollar just for illustration purposes. Then what I have to do simply is file a form--it's form 709--with my annual income taxes for any amount over that $15,000, right? A dollar will be deducted from my federal exemption of $11.58 million. So if I gave my brother $15,000 and $1--don't do that for anyone else listening right now--then literally $1 will be removed from my federal exemption. Basically $11.58 million minus $1. Does that make sense? That means, let's say I died the next day. Then my federal exemption will be $11.58 million minus a dollar or minus whatever I gave over the gift tax limit. So I hope the gift tax limit now makes sense.
It's so simple once you understand how it's related to federal estate taxes and the federal estate exemption, but let's go into some other details because most of us won't ever have to fill or file a gift tax limit Form 709. Right?
And so first I think we need to talk about what exactly counts as a gift. The IRS defines this as any time there's a transfer of cash or property without receiving something of equal or fair market value and return. So simply I gave the example earlier, I gave my brother $15,000 and $1. That's a gift. Anytime I gift money to my parents, like buy them dinner. That's a gift. Obviously none of us keep track of that kind of stuff. I don't know about you, but I'm usually not giving gifts of $15,000 to random people. If you're one of those people that does that, let me know.
But the gift tax limit generally applies towards family members. So to give you an example, let's say that I decide to give my son a home that is worth $200,000. This is actually not uncommon, right? We see a lot of families gifting things like this. The thing is that is technically a gift because I gave Jack a property worth $200,000, meaning he didn't have to pay for it. One way to get around this-- If that's something you want to do and gift your children things like a home, which is super awesome, then you want to give them a loan, but you can't just give them a loan with any interest rate. The IRS requires you to give a loan with a minimum interest rate. There are these published federal interest rates. We'll put links in the show notes. Otherwise the IRS will see this as a gift. One scenario is okay, let's say I want to give Jack this $200,000 home. And let's say I'm married. But every year I can choose to forgive $30,000. Since the gift tax limit is $15,000 per person. And if I'm married, that's $30,000, do you get what I'm saying? And so every year I can forgive $30,000 of that loan towards that gift tax limit, or he can pay me back with the loan and he will pay back with interest. And that interest is something I would have to report on my income taxes. I'm sure you know that many people don't actually do this, but this is what you're supposed to do.
Let's also talk about the gift tax and married couples. This is definitely one of those big financial perks of being married. Basically, if you're married, you have the gift of unlimited gifts to your spouse. Now, this only applies if your spouse is a US citizen, meaning that I can give my husband a million dollars and he could deposit in his bank account. And there's no gift tax limit issue because he is my husband. But if your spouse is not a US citizen, there is a limit. I believe in 2020 it's to the tune of $157,000. So it's still pretty high, but it's not unlimited.
Now there are lots of exceptions to the gift tax, because if this wasn't the case, then I think a lot of us would be in trouble with the IRS. We sort of know these to be true, but let's spell them out. Anything you give to a qualified nonprofit organization, aka charity? No such thing as a gift tax limit. We kind of know this to be true because otherwise we'd all be in trouble. Gifts to political organizations are also exempt. Also payments made directly to educational institutions for tuition, like when you pay for your child's private school or college. Or if you're generous and you're paying for other people's schools, that's also exempt from the gift tax limit.
And then lastly, direct payments for medical care. Let's say you're feeling super generous and you want to help someone else who is paying for their medical care. If you make the payment directly to the hospital or to the doctor, that is also exempt from the gift tax limit as well.
So let's just summarize real quick. These are what are exempt from the gift tax limit: It’s gifts to nonprofit organizations or charity gifts to political organizations, direct to educational institutions for tuition and direct payments for medical care.
So, one thing I want to say about the gift tax limit is when it comes to your children--because a lot of us I know are interested in saving up for their college and will create multiple accounts like a 529, perhaps a Coverdell ESA or even a UTMA, which is basically a brokerage account for your children--did you know that these contributions are actually subject to the annual gift tax limit? Meaning that if you want to, let's say contribute $10,000 a year to your child's 529, then you basically have another $5,000 that you can use for the other things. I mentioned like the ESA or brokerage account before you have to file that gift tax. Now, if you are married, obviously that double, so it's $30,000. So just keep this in mind.
Now, there is one huge exception--the 529. You may have heard that you're actually able to front load your child's 529 with five years worth of contributions. This means that you can contribute a lump sum of $75,000 or $150,000. This is basically 15,000 times five or 30,000 times five all at once, but then you can't contribute again for another five years. This also means that you've also used up the gift tax limit, meaning you can't fund their other things like an ESA or UTMA.
Now this doesn't apply for gifts from other family members. Just to give you an example, you know, Jack's grandparents will sometimes give him cash gifts for his birthday. That's their gift tax limit. It doesn't apply to Jack or for me, do you get what I'm saying? Cause I think some people get confused, like only one $15,000 contribution can come through to a 529. It's just whoever's contributing to it. I can pop in $15,000. Matt can pop in $15,000. If his grandma wants to do the same, she could also pop in $15,000. The gift tax limit is per person coming from that person.
Okay. So that's kind of a birds eye view of the gift tax. And so finally, what I want to say is that very few of us will actually have to pay the gift tax. I should say, our estate will likely not have to pay for it. And then I also just want to make sure you understand that you can't just gift something like a house or pay for someone else's loans without filing this IRS Form 709. But in case you do, all that means is that you're reducing your federal estate exemption by the amount you over gifted, meaning that the gift tax is not calculated until you die. A lot of people think that the gift tax is paid by the person who gives it or the person who receives it. It's actually paid by a person's estate.
I hope this has cleared up the mystery of the gift tax. And like I said, the federal estate tax exemption is subject to change. It's always changing. The gift tax limit also generally goes every year or at least every other year to kind of keep pace with inflation. These numbers may not apply depending on when you listen to this podcast, but the general concept should hopefully be the same.
Hey, if you're a woman physician who is ready to take control of your money, you've got to check out my program Money for Women Physicians. It's part course and part group coaching and a hundred percent guaranteed to put more money in your pocket. Go to wealthymommd.com/money to learn more.
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