The federal tax code is very specific about how much you are allowed to gift others in any given year or over a lifetime.
If you go over that amount, you, the giver, get an unwanted gift from the Internal Revenue Service (IRS) in the form of a gift tax.
However, not every gift is subject to a gift tax. There are:
- Annual exclusion amounts
- Lifetime exemption amounts
- Education and medical exclusions
How is a Gift Defined?
The IRS defines a gift as the “transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return.
If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”
Another way to describe a gift is a transfer or any property in which you do not receive full consideration (equal value).
According to the IRS, full consideration is defined as fair market value.
The fair market value is the price determined by the buyer and seller in an open market when they have full reasonable knowledge about the property and are under no pressure to trade.
Exclusions to the Gift Tax
There are a few gifts that are not considered taxable. These include:
- Education exclusion: tuition paid on behalf of another person
- Medical exclusion: medical expenses paid on behalf of another person
- Gifts to a political organization
- Gifts to your spouse, as long as they are a US citizen
- Gifts to charities approved by the IRS
- Gifts to a single recipient in a single year that does not exceed the annual gift exclusion ($16,000 in 2022 per individual or $32,000 per married couple)
Lifetime Gift Tax Exclusion
In 2022, the lifetime exemption amount is $12.06 million for individuals and $24.12 million for married couples.
If your gift exceeds the annual exclusion amount, it may be subject to a gift tax if you have already used up your lifetime exclusion.
If the gift exceeds the annual exclusion amount or applies the annual exclusion to a transfer in trust, you must file Form 709, even if you do not owe a gift tax.
In most cases, individuals are unlikely to exceed their lifetime gift tax exemption. However, if they do, the tax increases proportionally to the taxable amount.
The lifetime gift tax exemption ranges from 18 percent for taxable amounts up to $10,000 to 40 percent for taxable amounts over one million.
The giver is responsible for the gift tax, according to the IRS. The donee can agree to pay the tax. However, the IRS advises that donees speak with a tax professional before making this choice.
If the donor owes the gift tax and does not pay it, the IRS could seize the gift or turn it to the donee for payment. This usually only happens when the donor is deceased.
How the Lifetime Gift Exemption Amount is Tied to the Estate Tax Exemption
Besides tracking the lifetime exemption amount, individuals with high net worth also need to be aware of how gifting can impact the estate tax that may be owed upon their death.
The federal estate tax is in force for estates valued at $12.06 million in 2022. The federal estate tax exemption is transferable between spouses.
The lifetime gift tax is tied to the estate tax exemption. The gift and estate tax exemptions are treated as a single amount. Over your lifetime, the amount of non-excluded gifts that you give counts against your lifetime exemption and could affect your estate tax.
For example, suppose a taxpayer has gifted $2 million in gifts that are in excess of their total annual exclusions, and they die in 2022.
Those $ 2 million counts against their lifetime exemption, reducing it to $10.06 million. If their estate is valued at more than $10.06 million, estate taxes would be due for any amount above this threshold.
To ensure that your gifting plans don’t backfire, talk to your estate planning attorney to verify that your gifts are properly accounted for, the right gift tax forms are filed, and your gifting plans fit your estate planning goals.
Contact an Estate Planning Attorney
Your estate planning attorney can ensure that you fully understand the tax implications of gifting: long-term estate tax implications and potential hidden costs of a gift, such as real estate taxes, transfer taxes, and capital gains taxes.