A Halloween Story about Gift Tax

Gifts are not taxable income. However, they can come back to haunt you!

There are three ways gifts can cause issues.

The first is if you are applying for a mortgage and the bank is trying to determine where you’re getting the money for your down-payment. They want to make sure you’re not taking out a side loan (and are hence a worse risk to them because of your greater debt burden.) If you are going to use gift money to buy a house,  they will want a letter from the donor (the person giving you a gift) stating it’s a gift and not a loan.

The second reason you’d want some evidence of a gift is to prove that it is not taxable income. Once I had a self-employed person get audited by the IRS. The first thing the IRS does with a self-employed person’s audit is add up all the deposits into his bank accounts to see if it’s more than the income he claimed. The IRS came back and said his deposits into his bank account were $8,000 more than he showed on Schedule C. In fact, they said, he’d left off all his August income. He exclaimed he didn’t even WORK that August! Curious, I asked why he hadn’t worked. Because he’d gotten married. Aha! Those deposits were wedding gifts, not subject to income taxes! (Happily, we could prove that a large deposit was from his parents.)

The third reason there’s paperwork around gifts is a bit complex. The first piece to know is that you don’t have to do ANYTHING if the gift was less than some “de minimis” annual exclusion. De minimis literally means “so little we can disregard it.” The annual exclusion was $10,000 for many many years, and started to climb with inflation a few years back. For 2022 it’s $16,000 per recipient. So you can give $16,000 to your daughter and $16,000 to your son and $16,000 to your son-in-law and $16,000 to your daughter-in-law… and if you’re married your spouse can do the same thing. That’s $16,000 all-in, including Christmas presents. (There are some exceptions surrounding payments made directly to a hospital or college.) Note that this figure is going up to $17,000 in 2023.

If you GET a gift of whatever amount, it’s all cool. Make a note in your checkbook, maybe copy the check for your tax files, and send a thank you note. (I didn’t have to tell you that, I’m sure.) You can stop reading here. Fa la la la la, enjoy your day!

The problem is if you GIVE a gift over the annual exclusion rate. Now you have wandered into the territory of estate taxes: the tax you get when you transfer money from one generation to another. Here’s how it works.

Imagine you’ve got a net worth of $13,000,000 and you’re feeling a bit peaked. Imagine also that you know that the estate tax exemption happens to be $12,060,000 right now. You gather your two beloved children to your bedside and say “here, each of you, have $1,000,000 each.” You bring your net worth down to $11,000,000 and then die the next day. Did you cheat the tax man? No! Because gifts over the annual exclusion amount get added BACK to your estate [transfer] tax return. In fact, all the gifts you made in your entire lifetime above the “de minimis” amount get added back to your estate tax return. Depending on the estate tax exclusion level in the year you die, the gifts you gave may or may not cause you to have to pay any actual tax, but all the gifts you ever made eat away at a lifetime exclusion that isn’t actually knowable until the day you die: estate tax exclusions bop around a lot depending on who’s in control of Congress.

How do gifts you made in 1997 get added to your estate transfer return when you die in 2047? Paperwork! Really dreadful paperwork that literally follows you to the grave. When you give a gift of over [whatever the annual exclusion is that year] you have to file a gift tax return and tuck it into a folder called “Estate of [Your Own Name]”. It’s gruesome. (I’m actually writing this on Halloween, in fact.) It’s not a hard return to do, but you’ll probably pay an accountant a couple of hundred dollars to do it, and you’ll be stuck with a folder in your filing cabinet that you have to make sure your heirs/accountants/lawyers know about when you die. (FWIW, most people with $12M have an accountant and/or lawyer and/or financial planner who can hold onto these files FOR you.)

Because this is a spooky story, I’ll throw one more boogeyman in: give away your house, and the Medicaid people might claw it back after you’re in the grave. That’s a topic for another day, though.

There you have it: give gifts of above $16,000 a year per person per recipient and you’re saddled with gruesome paperwork requirements. It’s not (usually) a tax, but it’s taxing nonetheless.

Happy Halloween!