22: The Misunderstood Gift Tax

One of the biggest barriers on the path to living a wealthy life are the common misconceptions around money. Oftentimes, well meaning people make off-handed remarks or pass along inaccurate information. It can stop us in our tracks. That is why this episode tackles the concept of the gift tax. It is one of the most commonly misunderstood parts of personal finance and estate planning. Let’s explore more. 

What is a gift tax? Before we can understand what a gift tax is, it is important to note that the gift tax functions with estate taxes. So let’s start there. 

Estate taxes are taxes that are applied to someone’s estate after their death before that estate is distributed to the beneficiaries. In 2020, the estate tax limit is $11.58 million for an individual or $23.16 million for a couple, meaning that your estate must pay an estate tax if your net worth exceeds that amount. 

A gift tax was established, at least in part, to prevent extremely wealthy people from dodging the estate tax by giving away large sums of money before their death. Essentially, the federal government limits how much money someone can give away each year without incurring a tax. Currently, the gift tax allows individuals to gift $15,000 per year as an individual or $30,000 per year as a couple without having to pay taxes. It is worth noting that gifts up to $15,000 can be made to multiple individuals or entities by the same gift-giver. 

So what happens if you give someone a gift greater than $15,000? If you make a gift to someone for more than $15,000 as an individual, file a gift tax return on the amount of money that exceeds $15,000, not the full amount. For instance, if you make a gift of $16,500 in a calendar year, file a return on the $1,500 overage. 

Interestingly, most of us will never pay a gift tax. Why? If you do exceed the gifting limits in a single year, you file Form 709 with the IRS. The amount that you would have to file for is then reduced from your overall estate tax limit. Using the $1,500 example from the scenario above, someone who files Form 709 would have a new estate tax limit of $11.58 million minus $1,500. Clearly, there is still plenty of wiggle room left in that limit. 

There are several notable exemptions from the gift tax. You are exempt from the gift tax if you make one (or more) of the following gifts:

  • Gifts to charitable organizations
  • Donations to political organizations
  • Direct payments to educational institutions 
  • Direct payments for medical care

In this episode, we also explore:

  • How gifting to multiple people or groups each year works with the gift tax
  • Several scenarios as to how the gift tax might affect supporting children with tuition or their first homes 
  • A deeper dive into how to charge interest on a gift such as a house
  • How gift tax exemptions work

Featured on this episode:

  • Review IRS Form 709, the United States Gift Tax Return form here.
  • Check out the list of Applicable Federal Rates from the IRS to see how to charge interest on a loan to family appropriately. 
  • Read more on what you should know about the misunderstood gift tax here.
  • Connect with a community of women physicians who are upleveling their finances in my Facebook group
  • Learn more about how to manage your mindset with Wealthy Mom MD.