A person who transmits anything of value to another without obtaining something of comparable worth in exchange is subject to the gift tax, which is a type of federal tax. Gifts can include anything of high value, including substantial sums of cash or real estate, and the tax can be applied even if the donor had no intention of giving the item as a gift.
The IRS imposes restrictions on the number of gifts you can make before being required to file a return and pay taxes. The amounts that are reported when they go over the annual levels are used to figure out a lifetime gift tax exemption amount. The gift tax is due once this large exemption has been used up.
What You Need To Know
- The gift tax is a federal tax levied on a taxpayer who gives money or property to someone else.
- The gift tax ranges from 18% to 40%, depending on the size of the gift.
- The IRS allows a lifetime tax exemption on gifts, which is adjusted yearly to keep pace with inflation.
- Gifts that are given to spouses who are U.S. citizens, to political organizations for use by the organization, and for medical and tuition-related expenses, along with gifts valued at less than the annual exclusion amount, are excluded.
- Gift splitting and gifts given in trust are two strategies to avoid incurring the gift tax.
What is a gift tax?
The federal gift tax was established to stop people from giving valuables to others in order to avoid paying income taxes. To avoid unfair hardship and to force donors and receivers to pay their taxes, the gift tax is implemented. Donors must fill out Form 709, Federal Gift Tax Return, and send it in with their tax returns by April 15 of the year after the donation.
The size of the taxable gift determines the gift tax rate, which can range from 18% to 40%.
Only annual gifts that are more than a certain amount are taxed. Gifts that are less than that amount are not taxed. For 2022 and 2023, the yearly exclusion is $16,000 and $17,000, respectively. As those are per recipient restrictions, you might give multiple gifts totaling up to $16,000 or $17,000 to various recipients without incurring a gift tax.
Even though you must declare a gift that exceeds the annual exclusion level but falls below the lifetime maximum, you won’t be responsible for paying tax on it.
The total amount you can donate throughout the course of your life is the lifetime exclusion. This exclusion is $12.06 million in 2022 and $12.92 million in 2023, adjusted annually for inflation. Before the gift tax is applied, the donor may give up on this sum. But there are still limits each year, so the lifetime exemption only applies to amounts that are more than the annual limits.
Factors to consider
Gift tax calculation formulas are included in Form 709. But, submitting Form 709 does not obligate you to pay the gift tax.
You won’t be subject to gift tax if you provide a gift that is greater than the annual exclusion cap ($16,000 in 2022 and $17,000 in 2023) but less than the lifetime cap ($12.06 million in 2022 and $12.92 million in 2023), but you still need to declare the gift.
- Gifts for the donor’s spouse. If the spouse is a U.S. citizen, an unlimited amount can be gifted tax-free. Gifts tax-free to a spouse who is not a U.S. citizen are limited to an annual adjusted value of $164,000 in 2022 and $175,000 in 2023.
- A gift to a political organization for its use
- Contributions made by a donor to a person or organization, such as a college, a doctor, or a hospital, for medical and educational expenses
- Donations to charitable organizations
- Gifts valued below the annual gift tax exclusion rate
Strategies for Gift Taxes
Gift tax can be avoided or minimized with the right techniques. They consist of:
You can double your presents by two once you are married. Keep in mind that the yearly exclusion refers to the maximum number of gifts that can be given to a recipient. As a result, spouses can make separate gifts of $16,000 or $17,000 to the same recipient in 2022 or 2023, even if they file a combined tax return. This essentially raises the present’s value to $32,000 or $34,000 per year without incurring the gift tax.
Gift splitting is a way for wealthy couples to give their children, grandchildren, and others large gifts each year. In addition to, for instance, tuition payments sent directly to a grandchild’s school or college—which are completely exempt from the gift tax—this gift may be made.
By setting up a certain kind of trust—the Crummey trust is the most common—to collect and give out the assets, donors can give gifts that are worth more than the annual exclusion without having to pay taxes.
Money distributed through trusts is often not subject to gift tax exclusion. Yet, a Crummey trust gives the beneficiary a fixed amount of time—say, 90 days or six months—to withdraw the assets. The beneficiary now has what the IRS calls a “current interest” in the trust, and this kind of distribution may be considered a tax-free gift. Of course, the receiver is only permitted to withdraw an amount up to the donation amount made to the trust.
Under certain 529 college savings plan contributions, you are allowed to give more than the yearly exclusion without lowering your lifetime gift tax exemption. In these circumstances, you must submit the form annually and record the one sizable gift as being disbursed over five years on your tax return. The only rule is that you can’t give more gifts to the same person during this time. If you do, your lifetime exclusion will be affected.
Gift tax examples
Here are a few illustrations of how the gift tax functions.
Let’s assume that in 2022, Taxpayer A gave a total of $100,000 to five people, or $20,000. Because each person can only exclude up to $16,000 per year, the lifetime exemption amount is lower by $20,000. This is because $20,000 of the total amount granted is not excluded. Taxpayer A now has $12.04 million left over from the exemption to donate before gift taxes are due after making these transactions.
Here’s another illustration. A grandma who wanted to support her granddaughter’s education in 2022 donated $20,000 for a year’s worth of tuition. She also donated the young woman $16,000 in the same year for books, materials, and equipment. Both payments do not have to be reported for gift tax purposes. The $16,000 is the most that can be given each year, and the tuition is not counted at all.
Grandmother would have given a reportable (but not taxable) gift of $14,000 ($30,000 less the annual exclusion of $16,000), which would have reduced her $12.06 million lifetime exclusion by $16,000 if she had gifted the future doctor $30,000 and the young woman had already paid for the school.
Is there a gift tax?
Gift taxes are based on a sliding scale that changes based on the size of the gift. It only becomes effective for gifts that exceed a predetermined IRS threshold. A fixed fee is first assessed, and then a rate of additional tax between 18% and 40% is applied.
Can I give someone a tax-free gift?
For the tax years 2022 and 2023, you may offer someone up to $16,000 or $17,000. If you give more than that ($12.06 million in 2022 and $12.92 million in 2023), your lifetime gift allowance will be depleted, and if that happens, the gift tax will apply.
Taxes are payable by the receiver of a gift?
Often, gift tax is not owed by the recipient of the gift. But the recipient can say no, especially if the amount is more than the donor’s lifetime gift tax exclusion.
What is the maximum amount I can gift my child?
You are exempt from the gift tax if you give your kid or grandchild the same amount that you can give to other family members or acquaintances, namely:
- $16,000 in 2022 and $17,000 in 2023 per recipient
- $12.06 million in 2022 and $12.92 million in 2023 over the course of your lifetime
The IRS periodically raises these ceilings to account for inflation. The $16,000 and $17,000 limits are for a single donor; therefore, a married couple can give the same child each of those amounts for a total annual donation of $32,000 and $34,000, respectively.
The gift tax is a federal tax that you must pay when you give money or other items of inherent value to another person or group of people without expecting anything in return. Instead of being imposed on the recipient, it is on the donor.
The gift tax was created, though, in such a way that very few people actually have to pay it. Gifts of all kinds, including those given to a spouse, are excluded. In addition, you can make lifetime gifts totaling eight figures before the gift tax kicks in, and even then, it only affects gifts that exceed that amount.