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How Does The Gift Tax Work?

Black box with blue ribbon sitting on desk top, representing the Gift Tax

So you’re thinking about giving a family member some money to help with a down payment on a home. Or maybe you want to help contribute to a college fund for your grandkids. But you have heard about a “gift tax” and don’t know if or how it could impact you.

The good news is that for most people, they will never end up having to pay gift taxes.

What is the Gift Tax?

The gift tax is a tax on transfers of money or property while receiving nothing or less than fair value in return. This can be anything from cash or stocks, to cars and property. A gift can even be the “sweetheart” deal you gave a family member by selling them something for far below what the real value was. Like the rest of our tax code, the gift tax can be confusing. But there are two key terms to know that will clear things up.

These terms are the annual exclusion and the lifetime exemption.

What is the gift tax annual exclusion?

The annual exclusion is the amount you can gift an individual and not have to file a gift tax return. In 2023 that amount is $17,000 and could increase next year.

    • This exclusion is per recipient, per calendar year. In 2023 you can gift $17,000 to as many people as you want with no tax reporting needed.  A spouse can also gift the same person $17,000, allowing a married couple to jointly gift $34,000 to any single person in 2023.

It is only when you give over the annual exclusion amount that you need to file a gift tax return. The gift tax is filed on IRS form 709. Filing a gift tax form does not mean you will actually owe gift taxes. This is the biggest point of confusion with how gift taxes work. Filing form 709 is simply a process to document with the IRS that a gift has been given. The amount you give above the annual exclusion simply reduces your lifetime exemption. Throughout your life, the IRS will add up these gift amounts filed. So as long as they don’t add up to more than the lifetime exemption amount, you should not owe any gift taxes.

What is the gift tax lifetime exemption?

The lifetime exemption is the amount you can gift over your lifetime before you pay gift tax.  For 2023 that amount is $12.92 million per person and could increase in 2024.

    • As long as you don’t give over $12.92 million over your lifetime as gifts, you won’t end up owing any gift taxes. This is a per person limit, Married couples in 2023 will have a joint lifetime exemption of $25.84 million.
    • The amount you gift under the annual exclusion amount each year does not count towards your lifetime exemption. It is not reported and it is not calculated into your total of lifetime gifts.
    • This exemption amount can change over time. In 2002 the exemption amount was $1 million. It was $5 million in 2011. It increased to over $11 million in 2018 with the passing of the “Tax Cuts and Jobs Act” in 2017.
    • This exemption amount is a common political talking point and could be changed as tax laws evolve.

Are there other ways to reduce or avoid gift taxes?

Certain transfers of money are not even considered gifts at all, no matter how much money is involved.

    • Money given to a spouse who is a U.S citizen does not count as a gift or require any tax filing as spouses have an unlimited marital deduction.
    • Money paid directly to an institution for medical expenses or educational expenses (tuition) on someone’s behalf do not count as gifts or impact gift taxes. This means they don’t count towards using up any of your annual or lifetime exclusions.
    • Money paid to a political party is not a gift or subject to gift taxes.
    • There is a unique feature of 529 plans where you can “superfund” the account. In 2023, super funding would allow you to fund a 529 plan with a large one-time contribution of up to $85,000 ($17,000 annual exclusion x 5 years), kick-starting tax-free growth. This allows you to give up to 5 years’ worth of the annual exclusion at once, without it reducing or counting against your lifetime exemption. You would need to report this on your taxes. This strategy can be used again 5 years later.
    • Gifts to charities count as charitable contributions and do not count as gifts.

Who pays gift tax and how much is the tax?

If the gift is above the annual exclusion amount, the person making the gift files the gift tax return, and if necessary at some point eventually pays the taxes.  The taxes on gifts above the exemption amounts can be up to 40%. There are no reporting responsibilities for the recipient.

If you are looking to make a gift to support someone you know, don’t let the concern over a gift tax sway your decision. The annual exclusion combined with the lifetime gift exemption allows you to give away millions without having to worry about gift taxes. And if you do happen to have the assets and desire to gift more than the lifetime exemption, know that there are a number of strategies that with early planning can help make sure you don’t overpay taxes.

Learn more about our tax planning services, or if you’re ready, schedule an appointment with an advisor.

Editor’s Note: This article was originally published on December 29, 2021 and has been updated with current IRS limits.

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