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Print this The Gift Tax Before moving significant amounts of wealth among your friends and family , it would be wise to understand the gift tax law. If you give people a lot of money or property, you might have to pay a fe deral gift tax. For inst ance, you can give up to the annual exclusion amount ($11,000 in 2004) t o a person, every year, without facing any gift taxes, and without the r ecipient owing an income tax on the gifts. And you can give up to $1,000 ,000 in gifts, total, in your lifetime, before you start owing the gift tax.
How to report and pay the gift tax The General Theory Behind the Gift Tax Most people with a lot of assets want to pass along their property to the ir children before death, to avoid huge estate taxes. The gift tax, whic h is rooted in estate tax law, was originally designed to thwart this ef fort. Here's How Your estate is the total value of all of your assets, less any debts, at the time you die. Under the laws in effect for the tax year 2004, if you die with an estate greater than $1,500,000, the amount of your estate t hat is over $1,500,000 will be subject to a graduated estate tax that cl imbs as high as 48 percent. That $1,500,000 is an exclusion, meaning tha t the first $1,500,000 of your estate does not get taxed. So why not give all of your property to your heirs before you die and avo id that estate tax? If you give away more t han $1,000,000 in taxable gifts during your life in an attempt to reduce the value of your estate so that you can avoid the estate tax, you, not the person who receives the gift, still owe a gift tax of up to 48 perc ent of the gift amount over $1,000,000 anyway. Yes, you get it for gift taxes, but here's the catch: It's the same $1,000,000 that's available to shelter your estate . So, if you use it to shelter your gifts from gift taxes, it can no lon ger be used to shelter some of your estate when you die. There is a difference, however, if you wait to transfer property upon you r death instead of giving gifts during your lifetime. The difference has to do with the tax basis of the property the recipient gets from the do nor. For example, if your son inherits your property, his tax basis woul d be the fair market value of the property on the date you die. However, if he receives the property as a gift from you, his tax basis is whatev er your tax basis was. And if he sells the property at a loss, the tax b asis becomes the lower of your basis or the fair market value on the dat e of the gift. That can mean a great deal when your son goes to sell the property. Of course, this raises the question: How do you determine the value of a particular asset, such as an old house? The original cost of the property and any expenses incurred as part of th e sale form the basis for the value, as far as taxes are concerned. This tax basis may go up and down over the years, as you add a new room or d emolish the barn. So if the house cost $150,000 originally, and you've i mproved it to the tune of another $50,000, the tax basis for the propert y would now be $200,000. Of course, the fair market value (the price you could get if you sold the property on the open market) is probably a lot higher than that. Example Your mother has a house with a tax basis of $60,000. If your mother gives you the house as a gift, your tax basis would be $60,000. If you inherit the house after yo ur mother's death, the tax basis would be $300,000, its fair market valu e What difference does this make? If you sell the house for $310,000 sh ortly after you get it: * Your gain on the sale is $250,000 ($310,000 minus $60,000) if you got the house as a gift. With the new tax laws passed in 2001, certain facets of these laws will c hange. The lifetime gift tax exemption is $1,000,000 and will continue to be $1,000,000 for the indefinite fut ure. So you can make gifts that are worth up to a million bucks during y our lifetime without paying the gift tax. The maximum gift tax rate for gifts exceeding $1,000,000 will drop from 4 8 percent in 2004 to 45 percent in 2009, and to 35 percent in 2010 and b eyond, which is the same as the maximum individual tax rate. So why did Congress dramatically reduce the estate tax, but keep the gift tax if the gift tax was originally created to prevent people from escap ing the estate tax? Probably because of the other main reason for the gi ft tax, which is to prevent family members from shifting assets among th emselves to equalize income-tax rates. In our progressive tax system, wh ere some people must pay much higher marginal tax rates than other peopl e, the gift tax restricts the ability of a family to minimize their inco me taxes by moving income-producing assets among the members. For tax purposes, a gift is a transfer of property for less than its full value. In other words, if you aren't paid back, at least not fully, it' s a gift. In 2004, you can give a lifetime total of $1,000,000 in taxable gifts wit hout paying a gift tax. But many gifts are not taxable, so they do not c ount as part of that lifetime total. Gifts Not Subject to the Gift Tax Here are some gifts that are not considered "taxable gifts," and therefor e do not count as part of your $1,000,000 lifetime total. Present-inte rest means that the person receiving the gift has an unrestricted right to use or enjoy the gift immediately. You can give amounts up to $11,000 to each person, gifting as many different people as you want, without triggering the gift tax. Gifts to foreign spouses are subject to an annual limit of $112,000, indexed for inflation. To qualify for the unlimited exclusion for qualified education expenses, you must make a direct payment to the educational institution for tuition only. If you want to pay for books, supplies, and living expenses in addition to the unlimited education exclusion, you can make a gift of $11,000 to the student under the annual gift exclusion. Example: An uncle who wants to help his nephew attend medical school sen ds the school $15,000 for a year's tuition. He also sends his nephew $1 1,000 to help with books and supplies. If the uncle had sent the nephew $26,000 and the n ephew had paid the school, the uncle would have made a taxable gift in the amount of $15,000 ($26,000 less annual exclusion of $11,000) which would have reduced his $1,000,000 lifetime exclusion by $15,000. The gift tax is only due when the entire $1,000,000 lifetime gift tax am ount is reached. Payments to Qualified State Tuition programs are gifts, so you can exclu de up to the annual $11,000 amount. If you want to contribute more than $11,000 in one year to a qualified state tuition program to benefit ea ch student, you can elect to spread the donation over five years in ord er to avoid using part of your $1,000,000 gift tax exemption. Example: A grandmother contributes $55,000 to a qualified state tuition program for her grandchild. She decides to have this donation qualify f or the annual gift exclusion for the next five years, and thus avoids u sing $44,000 of the $1,000,000 gift tax exemption. As a result, she mus t wait five years before she can give her grandchild an $11,000 gift wi thout affecting her gift tax exemption. Medical payments must be paid directly to the person providing the care in order to qualify for the unlimited exclusion. Qualifying medical expenses include: + Diagnosis and treatment of disease + Procedures affecting a structure or function of the body + Transportation primarily for medical care + Medical insurance, including long-term care insurance In addition to these gifts that are not taxable, there are some transacti ons that are not considered gifts, and therefore are definitely not taxa ble gifts. This is not considered to be a gift until the new joint tenant withdraws funds. On the other hand, if you purchased a security in the names of the joint owners, rather than holding it in street name by the brokerage firm, the transaction would count as a gift. Even if you later find out t hat you paid more than the item was worth, given the fair market value, the transaction is not a gift, just a bad business decision. Gifts Subject to the Gift Tax The following gi...
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