What Is a Gift Tax?

When you do something nice for someone, like giving them a financial gift, the last thing you want is to be smacked in the face at the end of a year with a tax bill for that money. Gift tax is something many people overlook when they are helping out their family and friends, and it can sneak up on you and land you with a hefty fine, if you don’t play your cards right. The good news is that there are lots of ways to give financial gifts without being subject to the gift tax and recent increases to the limit for tax-free financial gifts has made this even easier.

First, let’s clear up what exactly gift tax is. Gift tax is a tax on money and valuables that you distribute to family and friend over the course of your lifetime. There is a both a yearly maximum amount of gifts and goods you can give someone tax-free, and a lifetime limit for financial gifts. The annual limit is $12,000 in money and goods per person; that means you can give $12,000 to as many people as you like without triggering the gift tax. Over the course of a lifetime, you can give as many individuals as you like a total of $2 million in money and goods. This $2 million include money and goods given in life combined the amount left in your estate. Anything above that amount is taxable under the gift tax law.

When you give someone a gift above these amounts, it is you who is responsible for the gift tax, not the recipient. If the amount of money in your estate exceeds $2 million, and you have left your estate to a single person, than the money is directly withheld from your estate.

If you want to give more than $12,000 a year to a single person, there are some ways to get around the gift tax. If the financial gift is intended to pay for tuition, hospital bills, rent, or living expenses, pay the institution directly rather than giving the money to the individual to reimburse. If you are married, than both you and your spouse are each eligible to give $12,000 a year, so one of you can give a $12,000 gift, and the other can give a gift for the remaining amount you wish to give away. If the recipient of the gift is married, they and their spouse can each receive $12,000 individually without paying gift taxes, so make gifts to each of them separately. If you want to save money for your child’s college education, you can pay up to $12,000 a year into a college savings account tax free, without the entire account becoming subject to gift tax.

If you must give a gift that exceeds $12,000 and there is no way to avoid triggering the gift tax, don’t panic. Merely reporting the gift doesn’t guarantee that you will be hit up for money from the IRS. It is usually gifts in the hundreds of thousands of dollars, which begin to actually cost the giver some money. If you know that gift tax is going to be an issue for you, plan wisely. Look for other deductions in your tax bill. Make a charitable donation that can be a write off for you, or determine if any of your business or living expenses qualifies as deductions. When you are transferring large sums of money and dealing with complicated issues like gift taxes, getting a financial advisor involved will minimize your out of pocket expenses and make sure you have gone about everything in the correct manner.