If your old car gives up the ghost, it might sound like a dream come true if your grandparents offer to buy you a new car. For you, it is. Depending on what they purchase for you, however, your grandparents might have some tax decisions to make.
The Gift Tax
The IRS doesn't care when a taxpayer makes a gift, either in his will or during his lifetime. It still wants a piece of the pie when the property changes hands. The gift tax prevents taxpayers from giving away their wealth while they're alive in order to avoid estate taxes later. With some exceptions such as college tuition, the IRS says a gift is anything your grandparents give you for which you don't pay them fair market value. If they buy you a car, a gift tax may be due at the rate of 41 percent to 55 percent on a portion of that value as of 2013.
Luckily, the IRS doesn't care about small gifts. It's the big ones -- those that might deplete your grandparents' future estate -- that the government is concerned with. The IRS therefore allows each of your grandparents to give you $14,000 a year as of 2013 without worrying about the gift tax. If they both want to give you the car as a gift, they can give you up to $28,000 and only the balance of the car's value over this amount is subject to the taxes. Therefore, if they give you a $25,000 car, no taxes are due. If they give you a $30,000 car, $2,000 of the gift is taxable. If your grandparents aren't married and if one of them gives you a $25,000 car, he's incurred taxes on $11,000, the difference between the value and the $14,000 per person exemption.
The Unified Credit
The unified credit can also help your grandparents avoid paying a gift tax. The credit is $1 million as of 2013 and it applies to both gift and estate taxes, thus its name. Your grandparents can effectively charge the excess over the annual exemption amount to this credit, but each time they do, it depletes the credit. This leaves less of an exemption to protect their estate from paying estate taxes when they die. For example, if they elect not to pay the gift tax on an excess of $2,000, the $2,000 would be applied to the unified credit, leaving a $998,000 exemption for estate tax purposes. Their estate would not have to pay estate taxes on the first $998,000 of its value.
If your grandparents want to give you a luxury car worth more than the available exemption, they can avoid incurring gift or generation-skipping taxes if they remain the registered owners of the vehicle. The taxes only apply to gifts when ownership actually changes hands. After all, if they retain ownership of the car but give it to you for your use, it's still technically their asset and its value is still subject to estate taxes when they die.
- Bankrate.com: Estate Tax and Gift Tax Amounts
- Tax Policy Center: Wealth Transfer Taxes – How Do the Estate, Gift and Generation-Skipping Transfer Taxes Work?
- Forbes: IRS Announces Increase in Annual Exclusion for Gifts, Rest Remains a Mystery
- IRS: Frequently Asked Questions on Gift Taxes
- Manish C. Bhatia: Generation Skipping Transfer Tax
- Jupiterimages/Polka Dot/Getty Images
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