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Gift tax & tax treatment of gifts

Just in time for the holidays, estate-planning attorney and guest blogger Steve Chambers discusses the different taxes that apply to gift givers and recipients.

People frequently confuse the gift tax exemption with income tax on certain gifts they receive. In this post, we’ll try to explain the differences and see why some gifts end up being taxed.

A gift tax is a tax imposed on the donor (the giver of the gift). In the past the gift tax has been closely tied to the estate tax, which is a tax imposed on the estate of a decedent. In 2010, there was no estate tax, so the gift tax stood alone. However, under the new tax bill recently passed by the House, the estate tax will return in 2011, once again to be closely aligned with the gift tax. The connection between the two is the lifetime exemption, more technically known as the unified credit. The lifetime exemption (currently $1 million) can be used to offset a gift tax or an estate tax. Once it’s used up, it’s gone, so to the extent it is used to shelter gifts during life, it isn’t available to shelter part of an estate at death.

In addition, donors have annual exclusions of $13,000 per recipient, meaning they can give up to $13,000 per person every year. The number of recipients isn’t limited, and each year a new annual exclusion applies. The annual exclusion is frequently increased to keep pace with inflation. The reason behind the annual exclusion is to avoid imposing a tax on gifts routinely given, such as at birthdays, anniversaries or holidays. The important thing to remember about the gift tax is that it is imposed on the donor (the giver of the gift), not the donee (the recipient of the gift).

However, when we look at the recipient, he or she may have to pay an income tax on a gift received, even if the donor doesn’t have to pay a gift tax. The Internal Revenue Code in section 102 says that property acquired by gift, bequest, devise or inheritance is not included in the gross income of the recipient, and, therefore, the recipient doesn’t have to pay a tax on the value of the gift. The real question is whether something qualifies as a true gift.

Many items might appear to be gifts at first blush, but courts have held that the test of whether something is given as a “gift” depends on the donor’s intent. If the donor shows a “detached and disinterested generosity,” the item given will be considered a gift for purposes of excluding its value from the recipient’s income tax. However, if that detached and disinterested generosity isn’t present, the “gift” might actually be income to the recipient. Here’s an example: Oprah is famous for (among other things) giving away new cars to members of her audience. The recipients don’t have to pay Oprah anything. Hence, you would conclude the car is a gift. But the question, according to the courts, is Oprah’s intent. Was she really motivated by “detached and disinterested generosity?” Hardly. Those cars are promotions for her, and you can bet she claimed the costs of the cars as business expenses. It’s like giving free samples when a new restaurant opens, or giving goodie bags at local 10k races. Technically, everyone who receives one of those samples or goodie bags should include the value of what they received in their income for that year.

So, there might not be a gift tax on something someone gives away, but there might be an income tax on that same thing.

Steve Chambers has been an attorney in Salt Lake City, Utah, since 1976. He is currently with the firm of Nielsen & Senior where he practices in the areas of estate planning, elder law, estate and gift tax and personal financial planning. In addition to being a lawyer, he holds an MBA from the University of Utah. Read more from Steve Chambers at his blog.

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