Parents give gifts to children on many different occasions like birthdays, Christmas and graduation. Many people give gifts without giving thought to the tax implications of gift giving. While small gifts are usually not subject to taxation, the Internal Revenue Service imposes a gift tax on gifts that exceed certain cash values. Parents should be aware of gift tax laws before giving large gifts.
Parents will not incur the gift tax if they only give small gifts because the IRS allows an annual exclusion of up to £8,450 (in 2010) on gifts to a specific individual. If a single parent gives a child £8,450 of gifts or less within a year, she will not incur the gift tax. Multiple gifts accumulate toward the annual limit. For instance, if you gave a child a car worth £6,500 and then a cash gift of £5,200 later in the year, the total would exceed the annual exclusion so you would be subject to gift tax.
Married couples can exclude twice as much from the gift tax as single parents when giving gifts to children. The IRS allows parents to add their individual annual exclusions, meaning two parents can gift £16,900 to a child in a year without incurring gift tax. According to the IRS, the exclusion amount was £14,300 from 2002-2005 and £15,600 from 2006-2008; the exclusion amount may increase in the future.
There are separate gift tax exclusions for each individual that a person gives to during a year. For instance, you could give £6,500 to two or three different children without incurring the tax because the total would not exceed £8,450 for any individual child. This can enable a parent or grandparent to gift significant amounts of money tax free by spreading gifts across many recipients. If you and your spouse had 10 grandchildren you could gift over £130,000 a year without going over the exclusion limit.
Gifts that go toward specific uses can exceed the normal annual exclusion amount and still go tax free. The IRS states that gifts that go toward education expenses like tuition are generally tax free. This is a significant benefit since parents often pay a large portion of a child's college tuition. The IRS also says that money given that goes toward medical expenses is typically tax free.
Lifetime Gift Exemption
There is an additional lifetime gift tax exclusion above the normal annual exclusion of £8,450 a year. According to Charles Schwab, "each donor has an aggregate lifetime exemption of £0.6 million before any out-of-pocket gift tax is due" above the annual exclusion. This can allow those with significant assets to make several large gifts that exceed the annual exclusion over the course of their lifetime without incurring the gift tax.