You may even have to pay taxes for the donation. The person receiving your donation does not have to report the donation to the IRS or pay gift or income taxes on its value. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule.
Generally, the following gifts are not taxable. The assets you receive as a gift or inheritance are not usually taxable income at the federal level. However, if the assets later produce income (they may earn interest or dividends, or you collect rent), that income is likely taxable. IRS Publication 525 contains the details.
In addition, some states have inheritance taxes. First, let us ease your mind. The total amount of the donation must be quite substantial before the IRS notices it. The IRS will provide a copy of a gift tax return when Form 4506, Request for Copy of Tax Return, is successfully completed and submitted with justification and payment.
Because of the increased likelihood that the lifetime exemption will be reduced, estate planners are encouraging many people to consider reducing the value of their properties by making tax-free donations of assets as long as they are able to do so to the extent that assets are not needed to ensure retirement security. Any lifetime donations that exceed the annual exclusion and do not qualify as tax-free medical and educational gifts are deducted from your lifetime exemption. Gifts must be made directly to an educational institution, not as reimbursements to the student or parent. For a discussion of strategies in this area, see “Effectively Using the annual gift Tax Exclusion (Part I), by John Scroggin, in the June 2001 issue of The Tax Adviser.
These donations will not count toward your estate and lifetime gift tax exclusion, and the recipient will not owe any federal gift or gift tax. Sometimes, a taxpayer is unwilling to make donations because potential donors have not used the money correctly in the past or because the taxpayer wants to delay their access to the benefits of the donation. Instructions on how to use the Electronic Federal Tax System (EFTPS) can be found in Publication 4990PDF (do not use Publication 4990 for the same-day electronic transfer payment method). If you want to help a family member with medical or college expenses, it may be better to pay the school directly to avoid any additional taxes.
Payments for any item that would qualify as deductible itemized medical expenses on an individual income tax return qualify for tax-free medical gifts. To the extent that your lifetime exemption is not used for lifetime gifts, the rest will be used to reduce wealth taxes. The bad news is that you'll have to file a gift tax return, but the good news is that you probably won't pay a gift tax. Most estate planners expect that the lifetime exemption that applies in a year when a donation is made will determine whether it is tax-free or not.
If you donate more than the exclusion to a payee, you'll need to file tax forms to disclose those gifts to the IRS. In addition to the annual gift tax exclusion, donors must be aware of the basic exclusion amount.
