05 Dec Are taxes owed on gift from in-laws?

Q. My father-in-law wants to help us buy a house. We know he can gift money to us both. How does that work, and will we have to pay taxes on the money?
— Trying to understand

A. Many people find the tax laws on gifts to be confusing.

But let’s start with income taxes.

Recipients of gifts, especially large cash amounts, often worry that they will owe income taxes on the gift, said Andrew Novick, a certified financial planner and estate planning attorney with The Investment Connection and Brookner Law Offices in Bridgewater.

But, a gift is not income and is therefore not taxable income to the recipient.

“Perhaps the confusion arises because game show or lottery winnings, which often feel like gifts, are taxable,” he said.

Similarly, Novick said, donors often ask if gifts to the children, grandchildren, or others are deductible. The answer is no. Gifts to other people are never deductible, he said.

“I understand the rationale for the question, which is probably based on the fact that charitable donations – basically a gift – are often deductible,” he said. “Even here, the donations are only deductible if you itemize your deductions and only about 30 percent of all taxpayers itemize, according to taxfoundation.org.”

Now let’s get to the gift tax, which applies to lifetime transfers.

The recipient of a lifetime gift will not owe gift tax, Novick said. Only the donor is subject to the gift tax, but most never even have to file a gift tax return because of two big exceptions – gifts to a spouse and gifts under the annual exclusion amount.

“Excluding gifts between spouses makes sense since spouses are generally considered a single unit for tax purposes,” he said. “The annual gift exclusion, which is $14,000 in 2017 — increasing to $15,000 in 2018 — covers most other routine gifts.”

Every taxpayer can gift up to the annual exclusion amount to an unlimited number recipients with no gift tax, Novick said.

So in your case, if your father in-law acts before year-end, he can gift you $14,000 and then in the beginning of 2018, he can gift you another $15,000 with no reporting requirements, Novick said.

If you are married, he can make the same gifts to your spouse.

“Assuming that your father in-law is married, his spouse can do the same thing – doubling the amount that can be gifted to you and your spouse with no reporting requirements at all,” he said. “The total of these gifts ($14,000 x 2 x 2 + $15,000 x 2 x 2 = $116,000) should definitely help towards the purchase of a home.”

But there’s more to consider.

If the timing won’t work out or if your in-laws are planning to gift you more than the annual exclusion amount, then they will need to file a gift tax return, Novick said.

Still, it is unlikely that they will pay any gift tax.

They can claim the gift in excess of the annual exclusion amount as a reduction against their future estate tax exemption amount, he said.

“The estate tax is a transfer tax at death and amounts in excess of the exemption amount are subject to the tax,” Novick said.

The estate tax exemption amount is $5.49 million per person in 2017, and it increases to $5.6 million in 2018.

Because most taxpayers’ net worths are far below this threshold – remember to combine the exemption amount for a married couple – reducing the exemption amount to account for lifetime gifts will probably have no effect, he said.

For instance, Novick said, if your in-laws gift you and your spouse $300,000 in 2017, the gift will be $244,000 over the annual gift exclusion. So your in-laws would report this amount on a gift tax return and can claim it reduces each of their estate exemption amounts by $122,000, leaving them each with a $5.368 million of estate exemption.

“If their net worth, including any life insurance, is under this amount at their death, there will be no estate tax so the large lifetime gift will have no income, gift, or estate tax implications,” he said.

Of course, your in-laws should consult with a financial professional to review their specific situation before making any decisions, Novick said.

Good luck with your new home!

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This post was first published in December 2017.