From individual income tax to property tax, there are many taxes that most people will pay just about every year. While the gift tax isn’t likely to be one of these, on the rare occasion that it applies to your situation, properly understanding it could save you a lot of money.
What is the Gift Tax?
Gift tax refers to the tax on property transferred between individuals where no consideration is expected in return. The exact nature of the transferred property has no immediate bearing on the IRS’s definition of a gift since any property—from money to land to stocks — can qualify as a gift for gift tax purposes.
What constitutes a taxable gift might surprise you. Spending money on vacations or college tuition is expensive, but lending interest-free money to friends and family also counts as a gift; because these loans are interest-free, the IRS may consider them gifts.
Who Pays Gift Tax?
Because the threshold for gifts that are subject to the gift tax is quite high, most people don’t have to worry about the gift tax. Generally, the IRS doesn’t require the filing of a gift tax return for gifts lower than $15,000 in 2021 or $16,000 in 2022.
Furthermore, the gift tax is measured per recipient, not as a net sum. In other words, the value of gifts given per year can exceed the annual exclusion provided that no aggregate gifts to the same individual exceeds the maximum annual exclusion.
As an illustration, in 2021, two gifts of $10,000 to two separate individuals are not subject to the gift tax because neither exceeds $15,000, but aggregate gifts of $20,000 to the same individual does require filing of a gift tax return.
Additionally, if you’re the recipient of a gift, you likely don’t need to pay gift tax either unless you use the gift to generate more income; the general rule is that the gift recipient shares the same adjusted property basis as the donor. Consequently, any income the gift produces after receipt are taxable.
You may wish to refer to IRS Publication 525 for more information, which covers taxable and nontaxable income. Many states also have inheritance taxes, but this information changes on a per-state basis.
How Does the Gift Tax Work?
If aggregate gifts to any individual exceed the annual gift tax exclusion, you are legally required to file a gift tax return; this most likely doesn’t mean you have to pay any gift tax, but it does mean you have to file an IRS Form 709.
Gifts that qualify for the annual exclusion (see above) are never taxed. Gifts made during your lifetime reduce your taxable estate. However, gifts in excess of the annual exclusion also reduce your estate tax exemption (see below). You won’t actually owe any gift tax unless you’ve exhausted your lifetime exemption amount. If you have exhausted your lifetime exclusion, the specifics of what’s owed vary, so refer to the instructions for Form 709 for any questions about the details.
Each year that a gift tax return is filed, gifts made in all prior years must be reported on the return.
What are Lifetime Exclusions?
In addition to the annual exclusion, you also have a lifetime exclusion for gifts. A lifetime exclusion represents the sum of gifts you can give throughout your life, though the actual number is regularly adjusted for inflation. For instance, the lifetime exclusion for 2021 is $11.7 million, and it’s $12.06 million for 2022.
In practical terms, this is the amount that an individual can give before the gift tax is applied. The $12.06 million estate tax exemption is set to be cut in half at the start of 2026 due to the expiring provisions in the 2017 Tax Cut and Jobs Act.
Are There Exceptions to the Gift Tax?
There are quite a few exceptions to the gift tax, beginning with how the tax changes based on your marital status. Married couples can gift each other an unlimited amount if both spouses are United States citizens; if a spouse is not a U.S. citizen, then amounts are limited to an annually adjusted value.
For 2021, the value is $159,000, and the value is $164,000 for 2022. Similarly, you are entitled to exclusions for jointly owned properties between you and your partner; the amount varies, but the total for 2022 is $32,000. This practice is generally referred to as “gift splitting,” and in practice, it doubles the amount you can give annually.
Other exceptions apply as well. Charitable donations do not count as gift tax or towards your lifetime exclusion, nor do donations to political organizations. Gifts that are valued below the annual exclusion are also omitted.
Medical and educational expenses, such as those paid to a college or a hospital, are also not counted. In order to qualify, payments must be made directly to the school or medical provider and not to the beneficiary.
Special rule for 529 plan contributions
Contributions to a 529 college savings plan are gifts to the beneficiary. However, a special rule allows you to make a lump-sum contribution and spread it over five years for gift tax purposes.
For example, you can contribute $75,000 in 2021 to start a 529 college savings account for your child or grandchild. If you’re married, your spouse can do the same.
- You can spread the gift over 2021-2024 without incurring any gift tax and without reducing your $11.7 million lifetime gift tax exemption or your $11.7 million estate tax exemption.
- Your spouse can spread his or her $75,000 gift over five years as well.
In order to take advantage of this rule, you can’t make any additional gifts to the same recipient during those years without using part of your $11.7 million exemption.
Seeking Aid with Taxes
If you need professional assistance filing your taxes, look no further than the firm of Cooke, Lavender, Massey, & Company P.C. to help. With over 80 combined years of experience helping clients with their taxes, our knowledgeable team of experts is experienced and ready to help you. Whether you are subject to the gift tax or otherwise need tax assistance, contact us today and speak to one of our certified accountants about how we can serve you.