Excludable Gifts

This question, in one form or another, comes up often enough that it’s worthwhile to address it here. One of my clients asked:

Is a gift under 13k tax deductible? I was reading the IRS website and I came across that.

Gifts are never tax deductible, unless they are made to a 501(c)(3) charity or similar organization. You can check here to search the IRS’s database for 501(c)(3) organizations:

http://www.irs.gov/charities/article/0,,id=249767,00.html

The Tax Code specifically excludes gifts from the gross income of the recipient. So if you were to give your child $5000 as a graduation gift, your child does not even have to mention that $5000 when he prepares his tax return.

So what’s with the special treatment of gifts under $13,000 my client saw on the IRS website?

Gifts are not taxable to the recipient, but they are sometimes taxable to the donor. The reason for this is that people used to avoid federal estate taxes by giving everything away on their deathbed. Since the estate tax is calculated as a % of asset owned at death, this strategy worked nicely to lower the estate tax to zero.

To prevent people from escaping estate taxes quite so easily, Congress passed a law that said any gifts given within 3 years of death had to be included in the donor’s estate. So people started making gifts earlier in life. For example, a person could set up a trust and make her grandchildren the beneficiaries. She could then contribute an office building to the trust and thus get the office building out of her estate. As long as the person lived at least 3 more years, the value of the person’s assets was reduced, and therefore the estate tax was reduced.

Congress reacted to this by passing a Unified Estate and Gift Tax. Over the course of his entire lifetime, a person can give up to a million dollars in gifts to recipients other than 501(c)(3) organizations. Gifts in excess of $1 million are taxable. To track the lifetime amount of gifts, a person if required to file a gift tax return every year a gift has been given.

But Congress really didn’t mean to require every birthday and wedding and graduation holiday gift to be reported. So the law exempts gifts of $13,000/year or less per donee. As long as you don’t give more than $13,000 to any one person during any one year, you don’t have to file a gift tax return. The $13,000 per donee exemption is per person, so a husband and wife can together give $26,000 per donee.

One of the ways to transfer a family business to the owner’s children is to give each child stock or LLC ownership units worth $13,000 each year.

To get back to my client’s question: no, you cannot take a deduction for gifts under $13,000; but you can exclude them when you calculate taxable gifts made during the year.