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Gift and Estate Taxes: Knowing What Needs to be Reported

The gift tax and estate tax only apply to gifts and estates greater than $5.43 million (or $10.86 million per couple). But even if you’re among the vast majority of Americans whose net worth is well below these amounts, it is still important to understand the basics of these tax systems. In this article, we explain how the gift tax and estate tax work and answer some of the most common questions our clients have about whether gifts need to be reported to the IRS.

Gift Tax: Understanding the Basics

The first thing to understand is that the donor, not the recipient, of the gift or inheritance is responsible for reporting it. (Gifts are transfers made while the donor is still alive, and inheritances are transfers made after the donor has died.) This is true regardless of the size of the gift or inheritance. For that reason, whenever you receive a gift or inheritance, you do not need to take any action as far as the IRS is concerned.

With that in mind, it is also important to understand that only gifts larger than the $14,000 annual exclusion need to be reported by the donor. The annual exclusion is Congress’s way of allowing people to give up to a certain amount ($14,000 for 2015) to loved ones and other recipients each year without triggering any gift tax implications.

The annual exclusion applies to an unlimited number of recipients, which means you can gift up to $14,000 in 2015 to as many people as you want without any of those gifts becoming a reportable gift. For example, if Scrooge McDuck gives $14,000 each to his great-nephews Huey, Dewey, and Louie in 2015, none of the three gifts are reportable. However, if Scrooge gives $14,000 to Huey and $14,000 to Dewey, but gives $20,000 to Louie, Scrooge would have a reportable gift of $6,000 for Louie’s gift ($20,000 gift – $14,000 exclusion).

A reportable gift, however, does not become a taxable gift unless the donor has already used up all of his or her $5.43 million gift and estate tax exemption. In other words, a reportable gift simply reduces the amount of the gift and estate tax exemption that is available for use. We will discuss the $5.43 million exemption in more detail later in the article.

It’s also important to note that spouses can combine their annual exclusion amount. Thus, Donald Duck and Daisy Duck can give up to $28,000 to an unlimited number of recipients in 2015 without incurring a reportable gift.

Some gifts, however, do not count as a reportable gift regardless of the amount. The following types of gifts are never reportable and never reduce the amount of the gift and estate tax exemption available:

  1. Payments that are made on behalf of a loved one for healthcare or education expenses, but only if these payments are made directly to the hospital, school, etc.

  2. Gifts to a spouse

  3. Gifts to charities or political organizations

If a gift is a reportable gift, the donor must file a gift tax return (IRS Form 709). The fact that a gift is reportable, however, does not mean that the donor automatically owes taxes on the gift. This is because there is an exemptionthat will apply to the vast majority of gifts.

Understanding the Gift Tax and Estate Tax Exemption

Every donor has an aggregate lifetime exemption that applies to all taxable gifts before any out-of-pocket tax is actually owed. In 2015, the exemption amount is $5.43 million, and the amount is adjusted annually for inflation.

Importantly, that $5.43 million exemption applies cumulatively to gifts and estates. This means that any amount of the exemption that applies to gifts made during a donor’s lifetime will reduce the amount that can be used for estate tax purposes upon the donor’s death. For example, if Scrooge gives away $4.43 million worth of taxable gifts during his lifetime, only $1 million of his estate will be exempted from estate tax when he dies ($5.43 million exemption – $4.43 million of exemption used for lifetime gifts = $1 million exemption remaining for estate taxes).

Spouses can combine their aggregate lifetime exemptions, so spouses may give away up to $10.86 million without owing any gift tax or estate tax.

Inheriting an Asset? Step Up Your Basis

When you inherit property or other assets, the dearly departed isn’t the only one giving you a gift. You also receive a potentially valuable gift from Congress: a step-up in basis.

A step-up in basis is a tax benefit that helps reduce the amount of capital gains taxes you may owe when you sell property that you inherited. A step-up in basis means that the value of the property for the purposes of determining your capital gains tax becomes the value of the property at the time of inheritance, not the value at which the giver initially purchased the property.

For example, suppose Donald Duck inherits his Uncle Scrooge’s house, a house that Scrooge originally purchased for $150,000 in 1995. In the 20 years since Scrooge purchased the house, it has appreciated from $150,000 to $400,000 at the time of Scrooge’s death. Donald’s basis on the house would get “stepped up” to the $400,000 it is worth at the time he inherits it, not the $150,000 that Scrooge paid for the house. Clearly, a step-up in basis can result in significant savings, especially for assets that have appreciated significantly from the time they were first purchased. The long-term capital gains tax rate is 15% for most people and 20% for high-income taxpayers like Scrooge.

The step-up in basis applies to all types of assets, including stock, a house, jewelry, or a piece of art. For houses and other assets that do not have an easily identifiable market value, it may be helpful to get an appraisal so that you can document the value and know your basis. And for those assets that have a more easily identifiable value (such as stock), it is still important to record the market value on the day that you inherit the asset, so you know what your basis is.

Hopefully, this article helps you understand the basic structure of how the gift tax and estate tax work. If you have any questions about what giving or receiving a gift or inheritance means for your specific tax situation, please do not hesitate to contact us at 773.525.6171 or


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