Making a Gift? – Make Sure You Know the Rules

Gifting property can be an effective way to spend down assets for future Medicaid eligibility and to reduce estate tax liability. Many people are not aware, however, that unless an exclusion or exemption applies, one must file federal and state tax returns on all gifts of property. Failing to file returns and paying gift tax when required can result in hefty penalties and interest.

A gift is any transfer of property where the person giving the property (the “donor”) receives less than fair market value in return. Generally, gifts are subject to taxes, unless an exclusion or exemption applies. Under both federal and North Carolina rules, a donor may give up to $12,000 per year to any person without incurring tax liability. A married couple may gift up to $24,000 per year to any number of persons, even if the gifted property belongs to only one of the spouses. Such “gift-splitting” requires the filing of a gift tax return.

In addition to the annual exclusion, the federal rules allow one donor a lifetime gift tax exemption of up to $1,000,000. However, to the extent this exemption is used, it reduces the amount the donor can pass on free of estate tax at his or her death. North Carolina allows only a $100,000 lifetime exclusion, for gifts to ancestors and descendents only. Using this $100,000 exemption does not reduce the amount one can leave at death free of North Carolina estate taxes.

However, the North Carolina rules may change in the near future. On February 15, 2007, a bill was introduced into the North Carolina General Assembly to reform the state’s gift tax to mirror the federal rules. If enacted, the changes would become effective on January 1, 2008 and apply to gifts made after that date.

Federal and state rules provide for other exemptions from gift tax consequences. For example, married couples may gift property to one another without any tax liability under the gift tax marital deduction. Additionally, gifts made to pay tuition or medical expenses are not subject to gift tax, as long as the payments are made directly to the educational institution or medical care provider.

If a donor’s gift does not fall within the annual and lifetime exclusions or an exemption, the donor must file a gift tax return by April 15 of the year following the calendar year when the gift was made. Since North Carolina’s rules differ from the federal law, there are situations in which a donor must file a North Carolina gift tax return even when a federal return is not required. A donor may apply for an automatic six month extension in which to file both federal and North Carolina gift tax returns.

Due to the complexity of the gift tax rules and the possibility of changes in the future, you should consult a CPA or tax attorney if you are considering making substantial gifts. Since current North Carolina gift tax laws do not follow federal guidelines, ensure the professional you consult is aware of North Carolina’s unique rules.