A tax professional's guide to taxable gifts

A parent buys a new car for a child who graduates from high school. The grandparents pay for the tuition of a grandchild. Do these taxpayers need to file gift tax returns and pay gift taxes? As always seems to be the case in tax, “it depends!” We're providing some insight into taxable gifts, how to calculate gift tax, and examples to help you better understand this topic.  

Table of contents

1. What is a gift for tax purposes?
2. When does a gift tax return need to be filed?
3. Gift tax rate schedule
4. Unified transfer tax credit
5. Tax planning strategies 

What exactly is a gift for tax purposes? 

The gift tax regulations refer to a gift as a gratuitous transfer of property. In simpler terms, we can think of a gift as a transfer of property where no benefit or value is received in return. However, the tax law identifies certain transfers that are not considered gifts for tax purposes. 

• Support payments where there is a legal obligation, such as a payment by a parent for basic needs of a child
• Contributions to political parties or campaign funds 
• Tuition paid directly to the educational institution 
• Medical expenses paid directly to the medical care provider 
• Transfers to spouses 
• Gifts to qualified charities 

When does a gift tax return need to be filed? 

A gift tax return, Form 709, is required when a U.S. citizen or resident makes a taxable gift, and special rules apply to nonresidents. To relax the administrative burden, the IRS allows an annual exclusion to be subtracted from all gifts made to an individual during the year. In 2024, the annual exclusion is $18,000. This amount is indexed for inflation, so it increases periodically in thousand-dollar increments. 

Unlike the individual income tax, there is no joint gift tax return. If required, each individual files a separate gift tax return. The gift tax return is always prepared on a calendar year basis, and Form 709 is due April 15th of the following year. A six-month filing extension is available, but any gift tax due must be paid by April 15 to avoid penalties and interest. If a taxpayer files an extension for the individual income tax return, the gift tax return is automatically extended. 

Funding Section 529 plans

For taxpayers who are funding Section 529 plans for their children or grandchildren, a special rule applies. The annual exclusion amount for five years can be used in the current year. Therefore, in 2024, a taxpayer could fund a Sec. 529 plan with $90,000 ($18,000 x 5) or $180,000, if married, without making a taxable gift. The drawback is the annual exclusion has been depleted for the next four years. 

Example 1 – Cash gift 

In 2024, Sandra makes cash gifts of $20,000 and $30,000 to her adult son, Michael. Sandra’s total gifts are $50,000, and her taxable gifts are $32,000 ($50,000 - $18,000). Sandra is required to file Form 709 to report her taxable gifts. 

Gift splitting 

Taxpayers who are married can elect to split the gifts on Form 709. Unless an exception applies, both spouses must file separate gift tax returns. Gifting splitting is advantageous as it allows two annual exclusions to be used. Special rules apply for spouses in community property states (e.g., Texas). 

Example 2 – Gift splitting 

Assume in the previous example that Sandra is married and elects to split the gifts with her husband. Sandra’s gifts of $50,000 to Michael are now split $25,000 each between Sandra and her husband. After subtracting the annual exclusion of $18,000, each spouse has taxable gifts of $7,000 ($25,000 - $18,000). Both spouses are required to file Form 709 to report their taxable gifts. 

Present and future interest gifts 

The annual gift tax exclusion is only available for a gift of a present interest. A present interest gift is available for current enjoyment by the donee. For a gift of a future interest, the enjoyment of the gift is delayed until an occurrence of a certain event. Future interest gifts are most common with trusts. 

Example 3 – Gift to Trust 

Alberto funds a trust for the benefit of his son and granddaughter. His son, Jacob, receives the income of the trust while Jacob is alive, and Alberto’s grandchild, Lucy, receives the remainder upon Jacob’s death. When Alberto transfers the property to the trust, he has made a present interest gift to Jacob and a future interest gift to Lucy. Only the gift of a present interest to Jacob is eligible for the annual exclusion. 

Gift tax rate schedule 

Like the individual income tax, the gift tax is a progressive tax where the rates rise as the tax base increases. The lowest rate is 18%, and the highest rate is 40%. However, due to the unified transfer tax credit, the only rate that is generally applicable is the 40% rate. Any gift tax due is paid by the donor (the individual making the gift), not the donee. 

Unlike the income tax, the gift tax computation is cumulative. Thus, taxpayers use their prior year gifts to calculate the tax on current year gifts. Because of this cumulative nature, gift tax returns should be kept forever.

 
Unified transfer tax credit 

Even if a taxpayer makes taxable gifts during the year, the taxpayer may not be required to pay gift taxes because of the unified transfer tax credit. The credit is “unified” because it applies to both the gift tax and the estate tax. The credit is equal to the tax on the “basic exclusion amount.” 

The Tax Cuts and Jobs Act of 2018 (TCJA) doubled the basic exclusion amount from $5,000,000 to $10,000,000. This amount is indexed for inflation, so it increases every year. If the TCJA is not extended beyond the December 31, 2025, expiration date, the basic exclusion amount will revert to $5,000,000 in 2026 (adjusted for inflation). 

In 2024, the basic exclusion amount is $13,610,000, and the unified transfer tax credit is $5,389,800. Therefore, a taxpayer can make lifetime taxable gifts of $13,610,000 without owing gift taxes. Any unutilized credit is available upon the taxpayer’s death to offset estate taxes. Similar to the annual exclusion, the unified transfer tax credit for married individuals can effectively be doubled by gift splitting. Furthermore, any unused basic exclusion amount, referred to as the deceased spouse unused exclusion or DSUE, can be transferred to the surviving spouse on the deceased spouse’s estate tax return (Form 706). 

Example 4 – Gift tax computation 

In 2023, Tinesha won the lottery and made a taxable gift (gift – annual exclusion) of $1,000,000 to her sister. The 2023 gift was the first taxable gift of her lifetime. Using the gift tax table, the tax is $345,800. Tinesha files a gift tax return, but the entire tax is offset by her unified transfer tax credit. 

In 2024, Tinesha makes a taxable gift to her mother of $15,610,000. To compute the gift tax in 2024, Tinesha must add her 2023 taxable gift of $1,000,000 to her 2024 taxable gift of $15,610,000 to give her cumulative taxable gifts of $16,610,000. The tax on the $16,610,000 is computed using the table. 

• Tax on $1,000,000 = $345,800 
• Tax on $15,610,000 @ 40% = $6,244,000 
• The total tax before credits is $6,589,800 ($6,244,000 + $355,800). 
• After subtracting the unified transfer tax credit, the gift tax due is $1,200,000 ($6,589,800 - $5,389,800). 

A shortcut can be used to double-check the computation. The basic exclusion amount of $13,610,000 can be subtracted from the total lifetime taxable gifts of $16,610,000 to equal the excess amount subject to taxation at the highest gift tax rate ($16,610,000 - $13,610,000 = $3,000,000). $3,000,000 x 40% = $1,200,000. 

Tax planning strategies 

To minimize the estate tax upon death, taxpayers will want to start with the lifetime giving strategy of making annual gifts. In 2024, $18,000 can be given to each donee tax free. For a taxpayer with two married children and four grandchildren, the taxpayer can give $128,000 ($18,000 x 8) without incurring any gift tax. If the taxpayer is married, this amount can be doubled to $256,000 ($128,000 x 2). Assets whose values are expected to increase (e.g., stocks, real estate, businesses) can be gifted to transfer the future appreciation out of the taxpayer’s estate. 

Taxpayers will also want to utilize the unlimited marital deduction to eliminate any estate taxes upon the death of the first spouse. Any DSUE amount should be transferred to the surviving spouse by filing an estate tax return for the deceased spouse. Taxpayers who are charitably inclined can reduce their taxable estates by supporting their favorite charities during their lifetimes and at death. 

Other estate planning techniques may include using life insurance, trusts, and family limited partnerships (with discounts for lack of marketability and minority interest). More advanced strategies will also aim to minimize the generation-skipping transfer tax. 

Final Thoughts 

This article scratches the surface on what is a very challenging area of the tax law. However, because of its complexity, gift and estate planning is well-suited as a niche practice area.

Take the next step with Becker's CPE courses

If you'd like to learn more about estate and gift taxes and more specialized tax planning, Becker has a wide variety of tax CPE courses designed to help you build your knowledge and skillset. Consider these CPE courses to take the next step: 

• Estate and Gift Taxes, Part 1
• Filing Form 709: How to Report Federal Gift Tax
• Tax Planning Strategies for Individuals

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