What is the Gift Tax and Why do We Have One?

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The gift tax is a tax the federal government imposes on an individual for gifts made during lifetime. The gift tax will apply to an outright gift or a gift to a trust.

The reason we have a gift tax is to prevent individuals from giving away everything they have during their lifetime in an effort to avoid an estate tax at death. Thus, if you give away everything away during life in excess of the gift tax exemption, you will pay a gift tax. However, if you hold onto your assets until you die, you will pay an estate tax at your death to the extent your estate exceeded the estate tax exemption.

Over the last few years, due to constantly changing laws, Congress created a lack of certainty regarding the amount which can be given away during life without incurring a gift tax.

The lifetime amount which can be gifted is called the gift tax exemption. This amount is cumulative and applies to all gifts made during one’s lifetime. Any gifts in excess of the gift tax exemption will be subject to a gift tax at the then prevailing gift tax rates. However, there are certain tax-free gifts that you may make beyond the gift tax exemption as described in the following question and answer.

The lifetime gift tax exemption and the estate tax exclusion are expressed as a total amount called the “unified credit.” The current amount of the credit for 2015 is $5.43 million per person and is scheduled to increase with inflation. You can use this total amount to transfer assets free of gift and estate taxes either during life or after death – or a combination of the two stages.

Gift tax returns are filed annually so that the IRS can keep track of how much of your unified credit has been used up when you die. For example, if you have used $1.43 million of the lifetime exclusion to make gifts to your family, the unused estate tax exclusion available to you if you die in 2015 will be $4 million instead of $5.43 million.

If you exceed your lifetime gift tax exemption, and/or your estate is larger than your unified credit, the maximum tax rate for 2015 is 40% on the overage.