We have a lot of clients in California who inquire about the California gift tax. Understanding how gift taxes work can be complex and is often even misunderstood by CPAs and legal professionals.
This post aims to break down how gift taxes work and point out any tips along the way.
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What is the gift tax?
A gift is generally defined as any transfer to an individual where full consideration is not received in return. The transfer can be direct or indirect, and it is measured monetarily. Also, if you sell something of value at less than fair value or if you made an interest-free or reduced rate loan, you just might have made a gift.
Simply stated, the gift tax is a tax on the transfer when it is made in excess of an exemption amount. The tax will apply whether or not the donor actually intended for the transfer to qualify as a gift. The gift tax also applies to the transfer by gift of any type of property. This could include real estate, stock, bonds, etc.
In fact, many parents make taxable gifts all the time to their children and don’t realize that they are actually taxable gifts. This can happen when a parent provides a down payment for a home or buys a car for a child.
The donor (person making the gift) is typically responsible for paying any gift tax due. Under special circumstances, the donee (recipient of the gift) can agree to pay the tax instead. But in practice, this rarely happens.
California Gift Tax
But I have some good news to report. California does not impose a gift tax on its residents.
This is really not that rare. Only 12 states have an estate tax, and very few actually have a gift tax. In many situations, people can just gift away their entire estate to avoid a state-level estate tax.
Annual gift tax exclusion
At the federal level, the gift tax exclusion allows a person to give away up to $15,000 annually to as many people as they want without filing a gift tax return or having those gifts count against the lifetime exemption.
Let’s assume that you are married and you have three children. Each spouse can give away up to $15,000 to each child annually. This would be $45,000 per spouse or $90,000 for the couple. Remember that this gift amount can be made each year.
But let’s take the above example one step further. Let’s assume each parent gifts $20,000 to each child. These $20,000 gifts would be considered taxable gifts because they exceed the $15,000 annual exclusion.
Even though they are considered “taxable,” you don’t actually owe any gift tax unless you have gone over your lifetime exemption amount. But you must file a gift tax return to report the taxable gift.
Tax-Exempt Gifts
We have defined above what a gift actually is. But certain gifts are exempt from the federal gift tax. Gifts made to the following entities can be made without any gift tax and without having to file gift tax returns:
- Gifts made to any IRS-approved charities;
- Gifts made to a spouse (assuming they are a U.S. citizen);
- Payments made to cover another person’s medical expenses, as long as they are made directly to a medical service provider;
- Payments made to cover another person’s tuition or college expenses, as long as they are made directly to the educational institution. Payments that are made for housing, food, books, and supplies don’t qualify for the exception but can be made by making payment directly to the student under the annual exclusion.
Tax Return Rules, Requirements & Limit
When you make a taxable gift (one in excess of the annual exclusion), you are required to file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return.
A few points to note:
- The tax return is required even though you may not actually owe any gift tax because of the lifetime exemption.
- The tax return is due by the tax filing deadline of April 15th in the year after you made the gift. This is the same filing deadline as Form 1040.
- If you extend your 1040 to October 15th, the extended due date will apply to your gift tax return as well.
Married couples are not allowed to file a “joint” gift tax return. Each spouse is required to file a separate gift tax return if they make any taxable gifts.
However, you are allowed to “split” the gifts with your spouse. When you make a split gift, you can take advantage of your annual gift tax exclusion and your spouse’s exclusion for a gift made entirely by you.
For example, let’s assume you gifted $30,000 to your child. If treated as a split gift, you are able to shelter the gift thanks to your $15,000 exclusion and your spouse’s $15,000 exclusion. As a result:
- No gift tax is due.
- The gift will not reduce the lifetime gift tax exemption or the estate exemption for either you or your spouse.
If you want to make a split gift, you are required to file Form 709, and your spouse must consent to the circumstance.
How to Avoid the California Gift Tax
Because California does not have a gift tax, you are probably in good shape. But you still could get caught in the federal gift tax. There are multiple planning strategies that can be implemented to minimize gift tax issues. Make sure to think of the following:
- 529 Plan Contributions
- Grantor Retained Income Trusts
- Grantor Retained Unitrusts
- Qualified Personal Residence Trusts (QPRTs)
- Grantor Retained Annuity Trusts (GRATs)
- Crummey Trusts
- Direct Medical Payments
- Special Valuation of Farms and Businesses
- Family Limited Partnerships
- Charitable Remainder Trusts
- Charitable Contributions
Final Thoughts
Owing any gift tax is usually not a big concern for most folks. It will only impact less than 1% of all taxpayers. Most people just don’t have the assets or estate value. But you may still have to file gift tax returns even though you don’t owe any tax.
Making annual gifts up to the exclusion is an excellent way to reduce your taxable estate without any adverse side effects.
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