By: Maryalene LaPonsie, U.S. News & World Report featuring Nick Strain, CFP®, CPWA®, AIF®, Senior Wealth Advisor at Halbert Hargrove
Cash is king, but you may have to tell the IRS if you’re giving or receiving it.
Whether you work in the gig economy or are giving a cash gift to a relative, you need to know if and how to report that money to the IRS. There are different rules and reporting requirements depending on the size of the gift, whether the gift was made in cash and whether you are the giver or receiver.
“It’s a good idea to do your homework,” says Daniel Ruppel, financial planning strategist with financial firm TIAA. “There are many nuances to tax rules.” He adds that it is always advisable to consult with a tax professional for guidance when giving or receiving money.
However, in general, these are the basics you need to know about cash gifts and cash payments:
Here’s a closer look at each rule and how it may affect you.
Cash Gifts Up to $16,000 a Year Don’t Have to Be Reported
Cash gifts can be subject to tax rates that range from 18% to 40% depending on the size of the gift. The tax is to be paid by the person making the gift, but thanks to annual and lifetime exclusions, most people will never pay a gift tax.
In 2022, gifts of up to $16,000 can be given without any tax or reporting requirements. “The $16,000 threshold is one person to one person,” explains Matthew Schwartz, a certified financial planner with Great Waters Financial in Minnetonka, Minnesota. That means, for instance, a couple can gift a combined $32,000 to each of their children in a single year.
The IRS defines a gift as a transfer of property in which there is no expectation of getting anything back, according to Shamisa Zvoma, a certified public accountant and tax principal with accounting firm Friedman LLP in New York City.
Qualified gifts, like those made to pay certain tuition or medical bills, are excluded from any tax requirement, but to be eligible for this exclusion, the gifts must be paid directly to the school or health care provider.
Excess Gifts Require a Tax Form
If a person’s gift exceeds the $16,000 exclusion limit, they must file Form 709 to report the excess gift to the IRS. But that doesn’t mean he or she will have to pay taxes.
“People feel like if they give more than $16,000, it will be taxable,” Schwartz says. “That’s not true.”
That’s because in addition to the $16,000 annual exclusion, there is an $12.06 million lifetime exclusion for the 2022 tax year. Anything reported on Form 709 is applied toward the lifetime exclusion. “Once you’re above the $12 million, there’s a tax that’s applied to that,” says Nick Strain, senior wealth advisor with financial firm Halbert Hargrove in Long Beach, California.
Married couples who file their tax returns jointly may also have to file a Form 709 even if their gifts are less than $16,000. For instance, a husband and wife could each give $16,000 to their child, but they would need to report the $32,000 to the IRS on Form 709 to properly split the gift between them.
“The reporting is really about keeping track of the lifetime gifts,” Ruppel says.
Gift Reporting and Taxes Are Required of the Donor, Not the Recipient
When it comes to reporting gifts and paying any taxes due, the burden falls on whoever is making the gift. “The recipient doesn’t need to do anything,” Zvoma says.
Depending on what the recipient does with the gift, there may be future tax implications, such as paying capital gains tax on an investment. But someone accepting money – even in excess of the annual exclusion amount – doesn’t have to worry about telling the IRS about it.
Capital Gains Tax May Apply to Gifts Accruing Value
The gift tax can apply to both cash and noncash gifts.
“If I sell you my brand new car for a dollar, that counts as a gift,” Ruppel says.
If you receive a noncash gift, you may end up paying capital gains tax on a portion of its value even if it falls below the gift tax exclusions.
For instance, let’s say someone gives you stock valued at $10,000, but they only spent $1,000 to buy it. When you sell those shares, your capital gains will be calculated based on the original purchase price. This amount is known as the basis. If you sell the stock for $10,000, you’ll pay capital gains on $9,000, which is the sale price minus the basis.
In some situations, such as the gift of a home, the recipient could be facing a significant capital gains tax if they sell the property. But a house that is inherited, rather than gifted, may avoid this tax burden since the basis for inherited property is reset to the market value at the time of the owner’s death.
Payments Between Individuals Don’t Have to Be Reported
For monetary payments that aren’t gifts, you likely don’t have to worry about any tax reporting. For instance, there is no need to tell the IRS about the money you paid to the person who mows your lawn, walks the dog or paints your spare room.
The same goes for cash received for most items sold privately. “If you’re selling something infrequently or as a hobby, you don’t have to report it,” Strain says.
However, there are exceptions to this rule. “One big question is whether or not these sales are part of a business,” Ruppel says.
If someone is buying items to resell online or is making regular income from their sales, their activity could constitute a business. In that case, the person would need to report the money as income on a Schedule C or other business tax form.
The other exception is the sale of collectible items that have appreciated in value, such as a classic car or original artwork. “You are required to account for capital gains,” Ruppel says, and that could mean paying tax on whatever profit you make from the sale.
Report Payments of $2,400 or More Made to Household Employees
While most cash payments don’t have to be reported to the IRS, the rules are different for some domestic workers, including nannies. If a person works exclusively for you and you dictate how they spend their day, the IRS would likely classify that person as a household employee and, Ruppel says, “Things can get complicated.”
Once an employee is paid $2,400 or more per year, you need to begin withholding Federal Insurance Contribution Act taxes for Social Security and Medicare. The cost of FICA is split between employees and employers so you will need to pay half of the 15.3% tax. Plus, you may be required to pay unemployment taxes as well.
If you have a household employee, you might want to apply for an employer identification number from the IRS. You also need to give your worker a W-2 each year and file a Schedule H Form 1040 with your own taxes to report the income paid. An accountant may be able to assist with this process or some tax software companies have programs for those who want to manage payroll themselves.
All Income Must Be Claimed, Even if Paid in Cash
In the wake of the COVID-19 pandemic, many people have changed jobs and some have embraced gig work that allows them to work remotely and on their own schedule. However, those receiving cash payments for any work should be mindful of their obligation to record that income and claim it on their federal tax forms.
Money from freelancing, consulting or other self-employment must be reported even if you don’t get a 1099 form from the person or company who paid you.
The IRS likely isn’t concerned with your teen’s babysitting money, but you could face penalties or audits if you are making full-time income from gig work and fail to report it. In the event of an audit, the government will compare deposits to your bank accounts against the income you report to root out any discrepancies.
It can be tempting to avoid filing forms or claiming income, but experts advise people to think twice before doing so. “That is tax fraud, and we don’t want to commit tax fraud because (that could lead to) going to jail,” Schwartz says.
Cash may seem like an untraceable way to give and receive money, but IRS regulations still apply. Whether you are giving a gift or paying a worker, make sure you understand these crucial tax rules.