The gift tax is perhaps the most misunderstood of all taxes. When it comes into play, this tax is owed by the giver of the gift, not the recipient. You probably have never paid it and probably will never have to. The law completely ignores gifts of up to $13,000 per person, per year, that you give to any number of individuals.
"Gifting is a great tool," says Erika Mielke, a senior wealth planning strategist for Wells Fargo Private Bank (wellsfargoprivatebank.com). "You can gift $13,000 to as many people as you want without paying gift tax."
For example, a mother with two adult children and four grandchildren, could gift $13,000 to each in 2012 for a total of $78,000 (6 x $13,000). You could do the same thing again in 2012. Over the two years, the taxable estate would be reduced by $156,000 (2 x $78,000) with no adverse federal gift or estate tax effects.
Who pays the gift tax?
If taxes are owed, the person who is giving the gift is generally responsible for paying the gift tax. Under special arrangements the donee may agree to pay the tax instead.
One important note: the gift tax applies only when a person is alive. When assets are transferred after death the estate tax comes into play instead. "Whether you gift during lifetime or wait until you die, depends on cash flow. "Before you make lifetime gifts make sure you understand what you have, how much income your assets generate, how much cost your assets incur, and how much you'll need for the long haul," Mielke says. "There's no rule that you have to make gifts. In fact, the greatest gift you can give your children is ensuring that they will not have to be financially responsible for you sometime down the road."
One word of caution regarding gifting. Beware of using gifting as a way to "spend down" to Medicaid. Before seniors qualify for Medicare assistance to pay for a nursing home, they must spend-down their assets. As of 2012, Medicaid will look back through the last 5 years for asset based transfers. (the look-back used to be 3 years). To say it another way, the IRS gift tax rules are totally different than those of the Medicaid rule.
For example, if someone applies for Medicaid long-term care assistance, that person's finances over the past five years will be reviewed. Even if they are less than the $13,000 IRS allowance, a portion of the gift might be deemed by Medicaid a "disqualifying transfer." Medicaid uses this equation: After looking back at gifts made over the past five years, the amount of the gift is divided by the average monthly nursing home cost. The number that results is the number of months the person is disqualified.
So for example if a person gifted $12,000 in the past 5 years and the average monthly nursing home cost of $4,000 per month, then the person is disqualified for three months from going on Medicaid.
The laws are confusing. When it comes to taxes, gifting and estate planning, don't go it alone. Work with a qualified Financial Planner.
For more information on the gift tax, see IRS Publication 950: Introduction to Estate and Gift Taxes.