How the Gift Tax Works

Have you heard of a “Gift Tax”?  Many people have heard the term, but few know what it means, what the tax implications are, and what exclusion limits exist. 

Gift tax is a tax paid, typically by the donor, on non-excluded gifts after a lifetime limit is reached. In some cases, the donee (recipient) may agree to pay the tax instead of the donor.  A separate tax return is required for the donor for the tax year in which the gift was given.  For example, if you give a gift that is not excluded in 2019, you will need to file a Gift Tax Return (Form 709) along with your personal tax return before the tax deadline in 2020.  Along with the return, copies of appraisals and other documents related to the transfer should be included. 

The donor does not pay taxes on the gift amount over the exclusion each year.  Instead, tax may come due when the donor reaches the lifetime exclusion gift tax limit.  For 2018 and 2019, that amount is $11.2 million.

A gift, according the IRS, is the transfer of money or property to a party in which the donor (person giving the gift) does not receive anything of equal value in return.  The gift can be all or part of the value in the transfer.  For example, money may be given and the gift value would be equal to the amount of money.  Similarly, if something was purchased by one individual as a gift for another, the purchase price would be the gift value.  Gifts can also be given by greatly reducing the sale price of an item below fair market value (such as a house or a car).  The gift is the difference between fair market value and the price paid.

There are a few exclusions to the gift rule.  First, there is an annual exclusion amount.  For tax years 2018 and 2019 an individual may gift up to $15,000 per recipient before a Gift Tax Return is required.  Other excluded gifts include tuition or medical expenses paid for someone, gifts to your spouse, or gifts to a political organization.  These gifts are not tax deductible.  The only deductible gifts are those made to qualifying charitable organizations. 

Here are some common scenarios related to gift tax returns:

Parents decide to gift a child the funds for a down payment on a home.  In this situation, if the amount given is greater than $15,000, a gift tax return should be filed along with the parents’ annual tax return the following year.  If the money is given as a loan, no Gift Tax return is required.  However, if interest is being collected on the loan, the parents should claim the interest income on their personal tax return in each year it is received.  Please note that according to the IRS, a loan that does not require interest payments is considered a gift. 

A home is sold to a friend or family member at a deep discount.  An off-market deal that takes into account no need for realtor fees being paid (for example, you do not list your home with an agent and instead sell it for slightly less than fair market value to account for not paying realtor fees) is not a gift.  However, if you sell a home with a value of $250,000 for $150,000, you have given a gift of $100,000.  In this situation you would need to provide an appraisal of the property at the time of the sale and any additional documentation related to the sale (such as the Settlement Statement) along with the Gift Tax return.       

If you buy a car for someone and put it in their name.  Often parents or guardians buy cars for their kids when they reach driving age.  However, the vehicle is often left in mom or dad’s name and is therefore still the property of the purchaser.  If that car were to be put in the name of the child, then the purchase price of the car would be considered the gift amount.  If the parents were to buy a car and many years later (such as when the child graduated from college) decide to put the title in the child’s name, the gift amount would be the value of the car at the time of transfer.  The original purchase price would not matter.     

If you are giving a gift to your child and his/her spouse.  Sometimes parents give a sizable gift to their child and his/her spouse.  In this instance, each party to the gift is treated separately for tax purposes and a Gift Tax Return is only required if a gift amount of $15,000 is exceeded per person.  For example, a woman wants to gift her son and his spouse the money for a down payment on a new home.  They need $25,000 which is $10,000 over the exclusion limit.  However, for gift tax purposes, the son and his spouse are treated as two separate gift recipients even if they file a joint tax return.  In other words, the woman can give them each $15,000 (for a total of $30,000) before a gift tax return would be required.  If the woman also has a spouse they could give a total of $60,000 before a gift tax return was needed ($15,000 from woman to son and $15,000 to his spouse; $15,000 from spouse to son and $15,000 to his spouse). 

Questions about Gift Tax rules and return requirements?  We’re happy to help!  Call or email our office for more information.

Surprised by a Balance Due or Decreased Refund? Here’s What You Should Know

This year was the first-time taxpayers filed returns under the new tax law.  There was a lot of information (and misinformation) in the news leading up to the official opening of the 2019 filing season and the frequency of news stories has continued.  We’ve had many clients receive a bit of a shock when given the results of their 2018 return.  Many were pleasantly surprised by a larger than normal refund or, for some, their first refund in a long time.  For others, however, the new tax law resulted in a smaller than normal refund, a balance due for the first time, or a larger than normal (or larger than expected) balance due. I want to help shed some light on the possible causes of these surprising results and help explain the steps you can take for a preferable outcome next year.

First, a quick overview of the changes affecting the largest percentage of taxpayers (i.e. changes to the standard deduction, reduction in withholdings, and loss of the personal exemptions).

  1. Standard deductions were increased significantly from $6,350 to $12,000 (single), $12,700 to $24,000 (married filing jointly), and $12,200 to $18,350 (head of household). On your tax return, you can take a standard deduction or the sum of your itemized deduction – whichever is higher.
  2. A new withholdings table was introduced under the tax law resulting in the automatic reduction of withholdings. This is the “more money in your paycheck” part of the new law. This means that the amount of money being withheld for tax purposes from paychecks and retirement distributions generally dropped unless you requested a change to your withholdings.
  3. Personal exemptions are gone ($4,050 per person). There are no exceptions!
  4. Changes to tax brackets resulted in an overall decrease in the tax liability for many tax payers.

*There are MANY other changes, but these are the specific items that had the greatest effect on many of our clients.

In previous years, the standard deduction or the amount of itemized deductions (whichever is greater) was added to total personal exemptions and dependent exemptions.  This amount was used to reduce a taxpayer’s adjusted gross income and arrive at taxable income.  This is the amount used to calculate tax due and is income tax calculation in its simplest of terms!  Income limits exist and there are many more moving parts in tax calculation.  However, for further explanation of the effects of the new tax law, this is really the key concept you need to keep in mind.

Group #1: A surprise refund!

If your return is the same as last year and you made no changes to withholdings and yet you find yourself with a larger than normal or first-time refund, this is probably the result of the increased standard deduction.  If you are a single filer and have not itemized deductions on your return in previous years, then you were most likely taking the standard deduction of $6,350 (in 2017) plus the personal exemption of $4,050 (2017).  This gives you a combined income reduction of $10,400.  Even though the tax law has taken away the personal exemptions, the increase in standard deduction gives the same individual an income reduction of $12,000.  That’s a $1,600 increase.

Here’s an example: in 2017 a single filer who receives a W-2, has no children, and does not itemize has $6500 withheld for federal tax from his paycheck during the year.  At the end of the year, the tax due is $5,100 so this individual will get a refund of $1,400 ($6500 – $5100).  In 2018, this same individual, with no changes to his filing status, has $5,900 withheld from his paycheck (a result of the withholding changes) and ends up with a balance due of $4,100.  This gives him a refund of $1,800 for the year.  Not only does he get $400 more from the refund, but he also kept an additional $600 throughout the year as a result of the decreased withholdings ($6500 – $5900).

20172018
Standard Deductions$6,350$12,000
Withholdings$6,500$5,900
Total Tax Liability$5,100$4,100
Refund$1,400$1,800

Group #2: Taxpayers with a smaller than normal refund 

This is still a group most people are okay with because it means they didn’t have to write a check on April 15, however we have many clients who had grown accustomed to a sizeable refund and were surprised by a decrease on their 2018 return.  For some, the drop has been only a few hundred dollars, but others have received refunds for many thousands less.  Most commonly with our clients we saw this as a result of the loss of unreimbursed business expenses deduction or write-off.  In the past, taxpayers who have received a W-2, but incurred personal expenses in order to do their job (i.e. mileage, car expenses, home office expenses, travel, client meals, office supplies, etc) could write-off many of those expenses against their W-2 income.  For many, these write-offs could be substantial – tens of thousands of dollars in some cases.  These high write-offs could give a W-2 employee with appropriate withhholdings a refund of, for example, $8,000 because of the significant reduction of taxable income created by the unreimbursed business expenses.  With those write-offs gone, an $8,000 refund could be closer to $1,500 this year.

Here’s an example: a sales rep with a total income of $100,000 in 2017 itemized her deductions at an amount of $55,000.  This included $50,000 in unreimbursed business, home office, and vehicle expenses.  This individual ended up with a taxable income of $45,000 and a tax bill of $12,750.  Her withholdings were based on a $100,000 income so total tax withheld from her paycheck during 2017 was $20,000.  This resulted in a refund of $7,250 ($20,000 – $12,750).   In 2018, however, this person goes from taking an itemized deduction of $55,000 (remember – $50k in unreimbursed business expenses) to taking the standard deduction of $12,000.  That is a $43,000 drop in deductions!  Her withholdings automatically decreased by about $2,500 (more money in her pocket throughout the year) and her refund dropped to $1,350.  That’s a total of $3,850 back ($2,500 + $1,350), but it’s a far cry from the $7,250 refund she had gotten the year before.

20172018
Income$100,000$100,000
Deductions$55,000$12,000
Withholdings$20,000$17,500
Total Tax Liability$12,750$16,150
Refund$7,250$1,350

Group #3: First time balance due or a larger than normal balance due

Unfortunately, we encountered many people belonging to this group during tax season. Tax payers typically found themselves in Group #3 for 2 reasons:  an increase in income (from W-2 or 1099s, retirement accounts, stock sales, etc) and a decrease in withholdings.  Many of our clients who found themselves in Group #3 on Tax Day typically had a balance due with their filing in previous years.  For most, they were actually paying less total tax for the year even in instances where they had a slight increase in income.  It was the decrease in withholdings and, occasionally, the loss of exemptions that really get them in trouble.

Here’s an example: a married couple with one dependent took the personal exemption deduction of $12,150 (4,050 x 3) in 2017 alongside an itemized deduction of $16,500. That’s a total deduction of $28,650.  That same couple in 2018 took the standard deduction of $24,000 resulting in a $4,650 drop in deductions without changing anything about their household or deductions.  Both individuals receive W-2s and had a combined income of $155,000 and a total tax liability of $24,500.  Their withholdings totaled $20,000 and their tax bill on April 15th was $4,500 ($24,500 – $20,000).  In 2018, their income increased to $163,000, but their withholdings dropped to $15,000 ($8,000 more in income, but $5,000 less in taxes withheld).  Their total tax liability dropped down to $21,000.  If their withholdings had stayed at $20,000, even with the $8,000 increase in income, their tax bill would have only been $1,000.  Unfortunately, the automatic drop in withholdings gave them a $6,000 tax bill ($21,000 – $15,000).

20172018
Income$155,000$163,000
Deductions$28,650$24,000
Withholdings$20,000$15,000
Total Tax Liability$24,500$21,000
Balance Due $4,500$6,000

 

Key points to remember:

  • The increase in standard deduction resulted in a sizeable increase in deductions for tax payers who did not itemize in the past.
  • The loss of personal exemptions is less than added benefit of the standard deduction in single or married filing jointly households that do not have dependents. However, households with multiple depends or households that typically itemized a significant amount of deductions on their return likely saw a negative effect from this change.
  • Unreimbursed business expenses (which includes mileage and home office expenses) are no longer deductible if you receive a W-2. There are no exceptions.
  • Changes to the tax brackets resulted in an overall decrease in tax due for most taxpayers. Even if you had a balance due this year (for the first time or a balance that was larger than normal), you likely paid less tax total for the year.

Quick tips for 2019:

  • Don’t find yourself with a surprise tax bill this time next year. Do a withholding check-up and increase your withholdings where necessary.  If you are a contractor or are self-employed, talk to your tax professional about making estimated payments.  Remember that the IRS adds a penalty if you owe more than $1,000 at tax time even if you are a W-2 employee with withholdings (see our previous blog post on estimated payments for an explanation of our “pay as you earn” system).
  • If you received a sizeable refund, consider updating your withholdings to allow yourself to keep more money throughout the year. A refund is better than a balance due but getting thousands of dollars back in April isn’t always for the best.  After all, the US government is the only bank that will hold your money all year and not pay you any interest!
  • Review which expenses are still deductible under the new tax law and keep good records throughout the year so you can make the most of your deductions.
  • If you are a W-2 employee who typically has significant unreimbursed business expenses, consider talking to your employer about becoming a statutory employee. This will allow you to retain the benefits of your W-2 while also bringing back many write-offs you have lost under the new law.  Only a few categories of workers qualify for statutory employee status.  Learn more about this option on the IRS website
  • Take advantage of retirement benefits offered by your employer or explore options on your own to reduce your taxable income while also saving for the future (401ks, IRAs, HSAs, etc).

 

TCJA Part 2: Changes to Standard and Itemized Deductions

This is the second blog in a series that explains the changes made to tax law under the Tax Cuts and Jobs Act (TCJA). Check out the first post here.

The following will discuss the major changes to the standard and itemized deductions. For reference, all tax returns are entitled to the higher of a standard deduction or itemized deduction. While some taxpayers will see no impact, there are many that will see a tremendous impact on their ability to deduct items such as state taxes paid, unreimbursed work expenses, and even investment advisory fees.  

The TCJA doesn’t impact the way that itemized deductions function; rather it changes the number of taxpayers that will itemize. Under the previous tax law (the one that you are filing your 2017 tax returns under), a single taxpayer can employ the higher of a standard deduction ($6,350) or total itemized deductions (more on these later). The standard or itemized deductions reduce taxable income, providing significant benefits to items such as owning a home, donating to charity, or grouping medical expenses. Along with the standard or itemized deduction, a single taxpayer also benefits from a personal exemption ($4,050) which further reduces taxable income. Under the TCJA, personal exemptions have been fully repealed and have been replaced with a higher standard deduction. The standard deductions have nearly doubled, increasing for single filers from $6,350 for tax year 2017 to $12,000 for 2018. While this may seem like a good deal, it may not be for those who have significant itemized deductions. While I used a single taxpayer as an example, you can see the changes to all filing types here.  Speaking of itemized deductions, let’s get to those changes! 

For tax year 2017, taxpayers that itemize can write-off the larger of either A) state and local taxes paid during the year or B) sales taxes allowable. I won’t go into the how the sales tax is calculated, but just know that there is a standard table that the IRS uses to calculate the allowable sales tax deduction. There is currently no ceiling on the deduction other than limiting factors such as AMT (Alternative Minimum Tax). The state and local tax deduction consists of state tax withholding, property taxes, Ad Valorem taxes, as well as other state and local taxes. For many taxpayers this amount can be quite large.  This is especially true for those in what are considered high tax states. Under the TCJA, the allowable itemized deduction for state and local taxes paid (or sales taxes paid) is capped at $10,000. For many, this will be highly impactful to itemized deductions, resulting in what would be a potentially large decrease in their yearly deductions.  

Are you thinking of buying a home with a jumbo loan of more than $750,000? If so, the TCJA limits the amount of mortgage interest that can be included in your itemized deductions. This means that the amount of interest allocable to the loan amount over $750,000 is not tax deductible. Under the current law the loan interest is limited to $1,000,000.  A change that is likely to impact more tax payers is the inability to itemize interest on a line of credit. If you are reading this and considering calling your mortgage broker in hopes of consolidating your loans – hold off on that for now. Since the TCJA does not change the definition of what a home loan is, your line of credit could still be deductible. The IRS will continue to allow interest on a loan, even a line of credit, if the funds are used as acquisition debt. I won’t get too technical, but just know that if you use a line of credit to either purchase or improve your home, then the interest is still deductible.  

The last major change to itemized deductions deals with what is labeled “Other Itemized Deductions.” While there are many items that make up Other Itemized Deductions, the large portion of these deductions include unreimbursed employee expenses, investment advisory fees, tax preparation fees, and work-related education expenses. Since this group of itemized deductions can be expansive, a follow-up to this blog will be released soon. The main point you should know is that the TCJA has repealed other itemized deductions in their entirety. 

In closing, the standard deduction and itemized deductions have been altered in a way that could have a significant impact on taxpayers. As always, you should evaluate your tax return or speak to your tax professional to see if any of these changes could have a negative impact on you.