Tax Basics in Hawaii: Gifting in Hawaii and the Federal Gift Tax

     Gifting property is a valuable estate planning tool, especially for those who wish to reduce their taxable estate.  In this post, we'll review some of the basics of gifting and the federal gift tax.  The federal government taxes gifts to prevent people from transferring all their wealth and money tax-free before they die, thereby escaping any estate taxes.
     What is a gift?  A gift is any transfer of property, made directly or indirectly, from one individual to another where the individual receives nothing or less than full market value in return.  Furthermore, a gift must be a "present interest", which is "an unrestricted right to the immediate use, possession, or enjoyment of property or income from property."  Examples of gifts may be selling something at less than full market value or making an interest-free/reduced interest loan.  Generally speaking, any gift is a taxable gift.  However, there are exceptions such as:

• Gifts not exceeding the amount of the annual exclusion;
  
• Payments of tuition or medical expenses for someone else made directly to provider or institution;
  
• Gifts to your spouse (unless spouse is a not a US citizen);
  
• Gifts to qualified religious, political, educational and other IRS qualifying organization.

     Who pays the tax on a gift?  Generally speaking, the donor is generally responsible for paying any tax associated with a gift.  A gift tax return (IRS Form 709) must be filed every calendar year a transfer by gift is made.
     Are gifts considered income by the donee?  Generally speaking, no.  The donee does not report any gifts received on his income tax return.  However, any income produced by the gift after it is received by the donee is considered earned income and must be reported.
     What is the annual gift tax exclusion?  The annual gift tax exclusion is the amount of property a donor can transfer to an individual that will not require the donor to pay tax on the gift.  In 2012, the exclusion amount is $13,000.  You can apply the exclusion to each donee.  For example, if you have five children, you can make separate $13,000 gifts to each of them.  
     What is gift splitting?  For married couples, a gift made by one spouse can by considered made by both spouses equally.  To split a gift, each spouse must file separate gift tax returns to show that gift-splitting was elected.  For example, if the wife gave $26,000 of her own funds to her niece, the husband can elect to split the gift on his tax return so that the gift is considered to be $13,000 from the wife and $13,000 from the husband.  
     What is the basis of a gift?  If a gift is not cash, generally speaking, the donor's holding period and basis will be assumed by the donee.  Therefore, the donor should provide any and all information associated with the non-cash gift (e.g. date property was acquired, adjusted cost basis and fair market value at time of transfer) to the donee so the donee will know what taxes may be due if the property is later sold by the donee.
     Does Hawaii impose a state gift tax? Simply put, nope!
     What are the benefits of making gifts?  First, it reduces your taxable estate.  The current federal estate tax exemption is $5.12 million, but may be reduced depending on what Congress does, if anything, in the coming months.  Making gifts can be a way to reduce your estate to below the exemption amount so that no estate tax will be incurred.  Second, it shifts potential taxable income to an individual who may be in a lower tax bracket then yourself.