Without the gift tax, families could avoid estate tax by making lifetime transfers to children, and gifts to children in a lower income tax bracket could reduce income tax as well. To the extent gift tax applies, these goals are frustrated.
The gift tax is imposed on lifetime transfers of property for less than adequate and full consideration in money and money’s worth. A transfer is subject to gift tax once it becomes a completed gift, leaving the donor with no power to change its disposition.
The tax on gifts is computed using the unified estate and gift tax rate schedule in 26 USC § 2001. A tax rate (40% on amounts greater than $1,000,000; lower rates on lower amounts) is applied to the taxable gifts made by the donor during the year and then subtracted from this result is any remaining gift tax exemption amount not used in previous years to offset gift tax. This is reported on Form 709, the federal gift tax return, which is due, along with any tax due, on April 15 of the year following the gift.
There is a marital deduction under IRC §2523 for gifts to a spouse who is a US citizen. Different rules apply when the donee spouse is not a US citizen.
There is a deduction for qualified educational and medical expense, and certain loans of artwork. IRC §2503(b)-(c), (e), (g).
There is a deduction for charitable gifts under IRC §2522.
A donor may generally exclude the first $14,000 (adjusted annually for inflation, though it will remain the same for 2014) worth of property given to each donee during a calendar year. To qualify for this non-cumulative exclusion, the donee must receive a “present interest” in the property—that is, an unrestricted right to immediate use, possession, or enjoyment of the property or the income from the property. There is no limit on the number of donees.
Gifts of community property are considered to have been made by both spouses (one-half each). Both spouses must join in gifting community property. Spouses may elect to treat gifts of separate property or quasi-community property as though these were made one-half from each spouse; this “split gift” election is made on the federal gift tax return for the year of the gift, and is usually done to more efficiently utilize the exclusions and lower tax rates which may be available to each spouse.
As the gift tax is unified with the estate tax, a lifetime exemption of $5,250,000 applies for 2013, inflation-adjusted to $5,340,000 in 2014.