5 Common Tax Myths About Gifts

Excited about giving or receiving gifts this holiday season? What’s not so exciting are the tax implications that may come with them. We often get questions about those implications this time of year so let’s take a look at some of the most common tax myths about gifts:

Myth #1: You have to pay tax on gifts you receive.

Reality: You don’t owe tax on gifts that you receive. Instead, the giver of the gift may owe tax. This may seem counter-intuitive but the whole point of the gift tax is to prevent people from using lifetime gifts to avoid paying the estate tax.

There are a few caveats to this though. The first is that gifts from your employer or in appreciation of your work may be taxable as income. That’s why tips are technically taxable even though they’re usually a voluntary gift rather than a required payment for service. (Don’t worry. Small de minimis gifts like a holiday turkey from your employer are excluded from tax.)

Second, if you’re given property that appreciated in value since the giver purchased it, you get the giver’s cost basis. That means that if you later sell it, you’ll have to pay a tax on the difference between what you sell it for and what the giver purchased it for. It’s kind of like a delayed tax on part of the gift’s value. If your grandfather gives you 50 shares of stock worth $20/share, and he paid $1/share for it long ago, you’re responsible for the capital gains tax on the $19/share gain, plus or minus any gain or loss on the stock once you own it.

The final caveat is that if you’re fortunate enough to receive over $100k in gifts from one or more related foreign individuals or trusts or more than $16,649 from a foreign corporation or partnership, then you’ll have to file Form 3520 with the IRS. That’s not because foreign gifts are taxable. The IRS just wants to make sure that you’re not claiming what would otherwise be taxable foreign income as a nontaxable gift.

Myth #2: You have to pay a tax on gifts you make that are over $15k per year.

Reality: Yes, $15k is the annual gift tax exclusion for this year. However, there are several other things to keep in mind too. One is that you can give an unlimited amount to a qualified charity or to your spouse without owing tax (unless your spouse is a non-citizen, in which case the annual exclusion is $157k).  

You can also give an unlimited amount if you send a gift directly to a medical or educational institution. That’s one reason (I’m sure you can think of more) that it may make more sense to write a check directly to junior’s college rather than writing him a check for that purpose. If you’re gifting money to a 529 college savings plan, you can give up to 5 years of gift tax exemptions upfront.

The $15k is also per person so you can theoretically give $15k gifts to a virtually unlimited number of people each year tax-free. (If this is your intention, don’t forget the person you heard this from.) You and your spouse can also combine your $15k exemptions to give a $30k tax-free gift.

Finally, even if you go over the exclusion limit, you still probably won’t owe anything to the IRS, at least not yet. That’s because the amount you go over the limit just reduces the $11.58 million (going up to $11.7 million in 2021) that you can give tax-free over your entire life or at death. Even if you don’t owe anything right now, you still have to file a gift tax return for going over the $15k limit though.

Myth #3: You can avoid the gift tax by loaning money at no interest and then forgiving the loan.

Reality: To be considered a loan, you have to treat it like a real loan. That means putting the terms in writing, including the repayment schedule, and charging a fair market interest rate, which is a rate above the Applicable Federal Rate. If you forgive the loan, it will be considered a gift at that point.  If you want to stay under the $15,000 annual limit, you can forgive $15,000 of payments each year.

Myth #4: Charitable contributions can always be deducted from your taxable income.

Reality: First, the gift must be to a qualified tax-exempt charitable organization. You can ask the charity if they qualify or search for the charity on this IRS site. If you receive something of value for your gift, you can only deduct the difference between what you gave and what you got in return. Finally, the charitable deduction has to be itemized. That means if your total itemized deductions (which includes your mortgage deductions) are less than your standard deduction, the charitable donation won’t reduce your taxes.

Myth #5: This is all you need to worry about.

Reality: Connecticut and Minnesota have their own gift taxes and some states may treat charitable deductions differently so be sure to check what your own state’s laws are. There may also be additional complications if you have a particularly complex situation. As always, consider consulting a qualified tax professional if you’re not sure about the tax implications of a gift.