Giving gifts is a way to show love and support for friends and family on special occasions, but gifts can also have an effect on your personal tax situation. The Internal Revenue Service offers tax deductions on many types of financial activities, but you cannot deduct gifts to friends and family to lower your liability. In fact, the IRS imposes a "gift tax" that can force you pay more taxes if you make too many large gifts.
Gift Tax Basics
Tax deductions and credits the IRS offers typically revolve around giving you tax breaks for activities it deems to be worthwhile, like having children, going to college, buying health insurance and giving to charity. Giving gifts to friends and family is a personal choice that generally has no bearing on your tax situation. The exception is if you happen to give gifts of substantial value. The IRS says that if you give gifts worth more than $13,000 to a single individual over the course of a year, the amount that exceeds $13,000 is subtracted from a lifetime unified credit of $5 million. If you use up your lifetime unified credit, further gifts in excess of $13,000 incur a gift tax. The annual gift exemption is $26,000 for married couples.
The estate tax is a tax due on the wealth or estate you leave behind to your friends and family after you pass away. Gift taxes exist to prevent people with substantial wealth from giving all of their money away to friends and family to avoid paying estate taxes. The $5 million unified credit applies to the estate tax, so if you don't use up any of your credit by giving large gifts, $5 million of the wealth you leave behind is exempt from estate tax. If you use up the unified credit by giving large gifts, your entire estate could be subject to estate tax.
Giving Can Reduce Estate Tax
Giving gifts to friends and family can potentially reduce estate tax liability for individuals with substantial wealth. You can give away $13,000 a year to as many recipients as you wish without eating into your tax unified credit. Giving $13,000 each year to family members like children and grandchildren is a way to draw down the size of your estate and reduce the amount of wealth you leave behind that is subject to the estate tax.
While gifts to friends and family members are not tax deductible, the IRS allows lets you take a tax deduction for charitable donations. If you give money to a religious institution or some of other type of charitable nonprofit organization like the Red Cross or Salvation Army, you can take a tax deduction for the amount given. You can also deduct gifts of property made to charity up the fair market value of the property. Fair market value is the amount property sells for on the open market.