What are Gift Taxes?

The federal gift tax applies to any transfer of property by gift. If a person gives property, which includes money or the use of or income from property, without the expectation that he or she will get something of equal or greater value in return, it is a gift. In addition, if an individual sells property for less than its value or makes an interest-free or lower-interest loan, it may be considered a gift. The recipient of the gift does not have to pay a gift tax or income tax on the value of the gift.

As a general rule, all gifts are taxable. Of course, there are exceptions to this rule. The following gifts are not taxable gifts:

• Tuition or medical costs paid directly to an education or medical institution on behalf of someone else
• Gifts to a spouse
• Gifts to a political organization
• Gifts to charities
• Gifts that are not greater than the annual exclusion for the calendar year (except for gifts of future interests)

The annual exclusion for 2008 is $12,000, which means that any gift of up to $12,000 is not taxable. The annual exclusion may be periodically increased due to cost-of-living adjustments. Thus, if an individual gave $10,000 to his cousin for her wedding, he will not be taxed. Likewise, if a person gave $11,999 to a friend, she will not be taxed. In addition, if a husband gives $15,000 to his wife, he will not be taxed because, even though the gift exceeds the annual exclusion amount, it is a gift to a spouse, which is excluded from taxation.

It is not necessary to file a gift tax return to report gifts of tuition or medical expenses or gifts to political organizations. For example, suppose John Smith paid a friend’s law school tuition of $50,000. Even though the tuition is higher than the exclusion amount, John would not be taxed as long as the tuition was paid directly to the educational institution. In addition, deductible gifts to charities in the form of the entire interest in property or a qualified conservation contribution that is a restriction on the use of real property do not have to be reported. A person must file a gift tax return (using IRS Form 709) if any of the following apply:

• The individual gifts items to at least one person (other than a spouse) that exceed the annual exclusion
• The individual gives a gift of a future interest to someone (other than a spouse) and the gift cannot be possessed, received or enjoyed until some time in the future
• A person gives his or her spouse an interest in property that will end with some future event involving his or her spouse
• A person split a gift with his or her spouse

Gift splitting is when a married couple makes a gift to a third party and it is considered as made one-half by the husband and one-half by the wife. Both spouses must agree to split the gift and each can take the annual exclusion for part of the gift. Thus, in 2007 (annual exclusion = $12,000), a married couple can give up to $24,000 without the gift being taxable.

The Economic Growth and Tax Relief Reconciliation Act of 2001 significantly changed the federal gift and estate tax systems. The top marginal tax rate applicable to gifts has decreased each year since 2002 to 45% for 2007. It will remain at 45% for 2008 and 2009. The Act also set the highest gift tax rate at 35% for 2010. The provisions set forth in the Act are set to expire at the end of 2010. If Congress does not extend the provisions, the rates will return to pre-Act levels.