If you’re eligible to pay U.S. tax, it’s important to understand the ins and outs of tax law to ensure you don’t file your tax return incorrectly. Many people struggle with the idea of gift tax, as the laws around this vary from country to country.
As an expat or US citizen living abroad, it can be confusing.
Let’s look at the basics…
What Is Gift Tax?
One of the major hurdles when filling out your U.S. tax return, is understanding exactly what tax you need to pay, how much and why. Gift tax amounts can vary depending on the amount or reason that you’re gifting assets or the reason that you’re receiving a gift and you can be taxed both for gifting and receiving assets or funds too.
Gift Taxes Explained
A gift tax is imposed when you transfer assets of value to another party without expecting anything in return. This could include large sums of money, properties, business assets or large value stocks or shares.
Depending on the value of the assets transferred, a gift tax could be imposed, even if there’s a contract in place and sound reasoning for the transfer other than as a simple gift. This could include handing over large value assets to another party as compensation for loss or as part of a legally binding contract.
Those receiving a gift could also be liable to pay gift tax once the asset has been transferred to them. This would depend on the amount or value of the transferred asset and the income of the receiver.
When Should People Pay Gift Tax?
There are a few reasons that someone may need to pay gift tax when moving money around.
- Someone may gift money to someone as part of a retirement plan in order to remove assets or money that they won’t be able to spend. This could be to a family member or friend.
- If a partner in a business intends to retire, they may gift assets to another partner when they step away.
- As part of a Will, someone may wish to gift a sum of money to a family member after they die. In this case, a tax payment may be requested by the receiver of the gift depending on their income levels.
Why Do We Have To Pay Gift Tax?
Gift tax was a tax put in place by the IRS to prevent tax evasion. Initially, the tax laws were based on how much you had currently in your accounts or held under your name in assets. This meant that people would only pay for what they owned at the time of the tax return.
People wishing to avoid paying tax would then be able to transfer large sums of money to other people, especially if they lived overseas, in order to avoid paying tax, as the tax laws in other countries differed.
Now, it’s perfectly fine to transfer large sums of money if required, as there is often a genuine reason for this – as part of a retirement plan for example. However, anyone transferring these assets would need to pay a tax to transfer, removing the incentive to move money around to avoid paying tax.
Gift Tax Thresholds
There are certain thresholds put in place by the IRS to help guide you when it comes to tax payments. Certain, smaller gift payments could be made without tax implications depending on how often you pay out your gifts and the income of both you and the receiver.
Typically, $16,000 is the threshold currently, so any gift payments under this amount annually would be exempt from paying tax.
As all gifts are considered annually, making multiple payments as a gift, whether to a single beneficiary or to multiple, won’t help you to avoid tax. This $16,000 is inclusive of all gifts paid throughout the full year, whether they are paid across multiple occasions, bank accounts or recipients.
The amount of tax you need to pay will depend on the size of the gift payment, but you can expect to pay anywhere between 18% and 40%.
If you have given a single gift that exceeds the annual exclusion of $16,000, you may still be able to avoid paying tax, or at least minimize your tax payments by declaring the gift on your tax return under the lifetime exclusion.
In 2022, the lifetime exclusion threshold is $12.06 million. This means that you can gift up to this amount during your lifetime without incurring extra tax.
If you exceed the threshold of $16,000 in one year and also exceed the lifetime maximum in this year, you could end up paying twice the tax if you don’t report it. Filing your gifts as part of your tax return will mean that you can avoid paying the full sum of gift tax until you’ve gifted over the lifetime limit.
How to Declare Gift Tax
If you intend to give a monetary gift or a gift of large value assets, you will need to declare the total sum in your annual federal tax return on April 18 using Form 709.
How Much Tax Do You Need To Pay?
It’s important to understand where you stand on the percentage payments for your tax depending on how much you gift to someone else. The percentage of tax that you pay will increase, the more you gift.
If your gift amount is less than $10,000 in one year, then you’ll be taxed at a standard 18%, which is what you could expect to pay on normal income taxes. However, as your gift amount start to climb to $10,001, you will start to incur 20% tax rates.
There’s an incremental increase of 2% or 3% each time you raise the amount by $20,000, ending with a total gift of $1,000,000, where the tax amount is 40%. This means that gifting a large amount in a single year may ultimately cause your beneficiary to receive less money in the long run.
Exceptions to Gift Tax Payments
Filing Form 709 along with your normal federal tax return doesn’t necessarily mean that you’ll be liable to pay gift tax as certain exemptions may apply. However, you still need to declare any gifts that you’ve given, otherwise the IRS may see this as a deliberate attempt to avoid paying.
You are exempt from paying gift tax if:
- You gift to your spouse who is a U.S. citizen. You are able to gift a total amount of $164,000 to your spouse annually.
- You intend to pay a gift to a political organization for their cause.
- You gift funds to an organization for medical or educational expenses. For example, to a college funding program, or to pay for a course, or to a hospital to pay for treatment.
- You intend to leave a large gift for charity. You can’t be taxed on money that you gift to reputable and registered charities for their use.
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Gift Tax Exemption Strategies
If you make a habit of gifting large sums of money, then it’s a good idea to keep track of your tax payments and learn a few tips to reduce your payments where you can.
If you’re married and file a joint tax return, then you can split the gift across both spouses, just like splitting your income tax amount if one spouse doesn’t work. This means if one person has reached their maximum for gifting in the year, they can allow the other spouse to gift the same amount within moving on to the next tax threshold.
Gifts in Trust
The Crummey Trust arrangement allows a person to distribute and receive funds as part of a trust, where the annual tax for gifting doesn’t apply. It allows both parties access to the funds for a specific period of time (usually 6 months), meaning it isn’t classed as a one-off gift payment.
College Saving Plans
Although annual gift tax is affected by payments into education, you can gift over your annual $16,000 into a 529 college savings plan without it affecting your lifetime tax exclusion.
These plans allow you to make a lump sum gift but spread the amount over 5 years for tax purposes as part of a college fund. This way the beneficiary can withdraw the amount over the 5-year period or choose to use it all at once. Either way, you will be taxed the same.
The small catch is that you won’t be able to give any other gifts to the same person throughout this 5-year period.
If you’re concerned about setting up a plan to reduce your gift tax payments, always speak to a professional. Setting up a trust or college fund incorrectly could cost you more in the long run.
If you’re concerned about the amount that you’d like to gift, or you need to know exactly what and how you need to declare your tax, then it’s worth speaking to a U.S. tax professional. They will be able to review your past payments and understand how to legitimately minimize your tax amount.
Filing US tax returns from abroad certainly complicates matters further, so get help from an expat tax specialist.
Remember, that even if you know you’re below the threshold, you still need to declare your gifts using Form 709 alongside your federal tax return.