In the United States, whenever we make a gift to someone, that is subject to tax. Note, however, that gifts being subject to tax is very different from paying taxes on the gift; most of your gifts will be subject to a tax rate of 0%. However, you may still need to file taxes.
What Constitutes a Gift?
From IRS Publication 559:
A gift is made if tangible or intangible property (including money), the use of property, or the right to receive income from property is given without expecting to receive something of at least equal value in return. If something is sold for less than its full value or if a loan is made without interest or with reduced (less than market rate) interest, a gift may have been made.
Gifts are not strictly money! Furthermore, if you were to offer an apartment for rent to your friend at $600/month, even though the prevailing rate for similar apartments in the area is $800/month, then by the last sentence, you are gifting your friend $200/month!
However, there are many exceptions to what constitutes a gift. Again from IRS Publication 559:
Generally, the following gifts aren't taxable gifts.
- Gifts, excluding gifts of future interests, that aren't more than the annual exclusion for the calendar year.
- Tuition or medical expenses paid directly to an educational or medical institution for someone else.
- Gifts to your spouse.
- Gifts to a political organization for its use.
- Gifts to certain exempt organizations described in 501(c)(4), 501(c)(5), and 501(c)(6).
- Gifts to charities.
A gift of a future interest is a gift that is limited so that its use, possession, or enjoyment will begin at some point in the future.
Be careful here. The tuition and medical expense exception is only when you pay for the expenses directly. Giving the money to your relative/friend/whoever for them to pay the expenses won't work!
The Annual Exclusion Limit
If you are single, you (the donor) can gift $15,000 (in 2018) per year to each donee of your choice without paying any gift taxes. If you are married, then you and your spouse can gift $30,000 (in 2018) per year. Just based on this alone, most people will never pay any gift taxes.
The Lifetime Exemption
If you give a gift to someone in excess of the annual exclusion limit, the amount in excess of the exclusion limit is subject to tax (though for most people, this tax rate will be zero). However, in this situation, regardless of whether you pay gift taxes or not, you are legally obligated to file gift tax returns.
The lifetime exemption doesn't make any sense with first discussing estate taxes. When you (and your spouse if applicable) die, your estate is subject to estate taxes. The taxable estate is the gross estate less allowable deductions.
Gross estate. The gross estate includes the value of all property the decedent owns partially or in full at the time of death. Your gross estate also includes the following.
- Life insurance proceeds payable to the estate or, if the decedent owned the policy, to
his or her heirs.
- The value of certain annuities payable to the estate or the decedent’s heirs.
- The value of certain property the decedent transferred within 3 years before death.
I'm not going to bother going into the the specific allowable deductions here, but you can find them here.
What's important though is you get a basic estate exclusion amount. In 2017, this base exclusion amount was $5.49 million (and double this if you are married). This comes from a $5 million base set in 2011, and is adjusted for inflation every year. With the new tax law, they doubled the $5 million base to $10 million (and again, double this if you're married) . However, in 2026, the $10 million base will be dropped back down to $5 million unless Congress passes another law.
Whenever you make a gift in excess of the annual exclusion limit, the excess amount gets subtracted for your basic estate exclusion amount. So long as the sum of your gifts over your lifetime in excess of the annual exclusion limit and the value of your estate doesn't exceed the basic estate exclusion amount, you will never actually pay any gift/estate taxes. However, the government does require you to track all the gifts you make in excess of the annual gift tax exclusion by filing a gift tax return.