Do you have to pay tax on all gifts that you give? For the majority of Americans, the answer is a resounding NO!
So, we all know that the federal government imposes a gift tax, but did you know that only Connecticut imposes a gift tax? Luckily, if you understand how the federal government’s gift tax works, you will understand the Connecticut gift tax, but just in case you don’t, the following is a brief overview.
What is a gift?
A gift occurs whenever you transfer something to another person or certain trusts for less than the item’s fair market value. Here are some examples:
- You own a car that is worth $10,000. You sell the car to your grandchild for $5,000. You have made a gift of $5,000.
- You give your grandchild $1,000 for graduating college.
For purposes of the federal government, all gifts are taxable gifts unless they fall into an exception. The main exceptions are:
- Gifts that do not exceed the annual exclusion (discussed below)
- Gifts for tuition and medical expenses (as long as the gift is paid directly to the institution or provider)
- Gifts to your spouse
A word of warning, if you or your spouse are applying or plan to apply for Medicaid (Title 19), the above exceptions do not apply. Medicaid penalizes just about all gifts, even those exempt from the federal and Connecticut gift tax.
About the Annual Exclusion
The annual exclusion exempts from gift tax those gifts made to a person in a given calendar year provided that the gift is less than $14,000. This means that you can give up to $14,000 to as many people as you want without triggering the requirement of filing a gift tax return or paying any gift tax. Let’s look at some examples:
- If, during the course of the year, you give $14,000 to each of your children, grandchildren, nieces, and nephews – you do not have to file a gift tax return or pay any gift tax.
- Same as above, except you give one of your children $15,000 – you have exceeded the annual exclusion amount for one child by $1,000 and must report $1,000 on your gift tax return.
- Same as above, except you give two of your children $20,000 each– you have exceeded the annual exclusion amount for two children by $6,000 and must report $12,000 on your gift tax return.
Who pays the tax?
The bad news – the person who gives the gift pays the tax. The good news – the government gives each person a credit to pay their gift and estate tax. In 2017, each person has enough federal credit to pay for gifts totaling $5,490,000 and Connecticut credit to pay for the tax for taxable gifts totaling $2,000,000. The federal amount is indexed for inflation, so it increases each year, but the Connecticut amount remains constant.
What does this mean? For a Connecticut resident with a net worth of less than $2.0 million, there is no need to be concerned about the gift tax. Such a person can give away their entire estate (not that I would recommend it) because their $2.0 million gift tax credit would fully protect the gift from any gift tax.
Remember, the credit is applied to the gift and estate tax. This means that you get one credit to either
1) shield large gifts from gift tax or
2) shield your estate from estate tax when you die.
If you use up all of the credit by making gifts, then, when you die, your estate will be subject to the estate tax because you will have no credit left. If, however, you do not use up all of your credit while you are alive, the executor or administrator of your estate can apply the remaining credit towards any tax your estate may owe.
What happens if you do not file?
If you make a taxable gift, that law requires you to file a gift tax return, even if you do not owe any money. Failure to do so can result in a late filing penalty. If you owe a tax and fail to file, you will also owe interest.
So during the New Year – go ahead and spread joy with your gifts. Just keep in mind the federal and Connecticut gift tax rules. You don’t want to pay more taxes than you have to.