The federal gift tax is one of the most misunderstood and often ignored taxes assessed by the federal government. In addition, Connecticut and Minnesota are the only states that currently collect a gift tax at the state level - Minnesota's gift tax just went into effect on July 1, 2013, but on the other hand, Tennessee repealed its state gift tax effective January 1, 2012. So what is the gift tax and who pays it?
What is the Definition of the Gift Tax?
The gift tax is a tax assessed on the value of property that is gifted from one person to someone other than their spouse (provided that the spouse is a U.S. citizen).
In other words, if you give jewelry, stocks, real estate or any other type of property to a family member other than your spouse (who is a U.S. citizen) or to a friend and in return they don't pay you for the full fair market value of the property and you have no expectations of getting the property back in the future, then you've made a completed gift that may be subject to the federal gift tax.
A gift tax may also be incurred if you add someone other than your spouse (who is a U.S. citizen) to your bank or investment account or to the deed for your real estate - these types of gifts are determined by applicable state law. And, of course, the gift tax also applies to gifts made of cash.
Who Pays the Gift Tax?
The person who makes the gift is the one who is responsible for paying any gift tax that may be due and reporting the gift to the IRS on a gift tax return - IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, and the applicable state gift tax return (if any). The federal gift tax return and any federal gift tax that may be owed are due on or before April 15 of the year following the year in which the taxable gift was made.
For the person who receives the gift, there won't be any immediate tax consequences since the gift won't be included as part of the recipient's taxable income. However, the recipient may incur capital gains tax when the gifted property is later sold because of the income tax basis that the recipient will receive in the gifted property.
What is the Recipient's Income Tax Basis in the Gifted Property?
When property is gifted away, the person who receives the gift will receive the gift donor's income tax basis in the gifted property as of the date of the gift. This means that for highly appreciated assets, such as stock or real estate that the gift donor bought at a very low value, the estate taxes saved by removing the value of the appreciated property from the gift donor's estate must be weighed against the capital gains tax that will be paid when the recipient later sells the highly appreciated property.