In 2020, the IRS collected $17.6 billion in estate and gift taxes. It’s important to pay appropriate taxes if you want to avoid fees and penalties from the IRS. Yet, how do you know whether something you’ve gifted requires a gift tax payment? Keep reading to learn more about gift taxes and how they work.
What Are Gift Taxes?
The Internal Revenue Service levies a gift tax. It’s a tax on transfers of property or money when the benefactor gets less than full value or nothing in return.
Most taxpayers don’t have to worry about gift tax. Up until 2021, the IRS wouldn’t levy a gift tax unless a gift exceeds $15,000.
In 2022, that amount has gone up to $16,000. Even if you were to give in excess of $16,000, you might only need to fill out some paperwork.
The Current Gift Tax Rate
There are a couple of gift tax exclusions we’ll cover in a moment. However, if you’re lucky and generous enough to reach the gift tax limit. If so, you may need to pay the gift tax.
The rates for gift tax can range from 18% to 40%. Usually, the benefactor will pay the gift tax.
There are some exclusions and special rules for calculating the gift tax. If you want to research the gift tax fully, you can review the rules for gift taxing by reading IRS form 709.
Things That Could Trigger a Gift Tax
Gifts are an excellent way to show people you care. However, extravagant gifting can unintentionally trigger the need to file a gift tax return. In some instances, however, it might prove wise to file a gift tax return even if it’s not necessary.
Imagine you gift difficult-to-value assets each year. For instance, you may give away interest in your latest endeavors if you’re a serial entrepreneur.
If you’ve met “adequate disclosure” requirements for those gifts, you’ll trigger a three-year audit limitation by filing voluntarily. You should speak with your accountant about this matter if you think this tactic may serve your interests.
Let’s have a look at a few more events that could trigger gift taxes.
Contributions to Grandkids Education
Imagine you’ve stashed away $60,000 for your grandchild in a 529 savings plan. Although well-intentioned, this contribution could trigger a gift exclusion tax because it’s over the limit.
However, one of the IRS’s exclusion rules allows you to spread one-time gifts over five years of tax returns. This rule enables you to preserve your lifetime gift exclusion.
As an aside, if you want to help the grandkids with college, maybe pointing their parents toward education tax credit info may help.
Paying for Kid’s Wedding
Imagine you’ve contributed $40,000 to your child’s wedding. Alternatively, you may pay for a wildly expensive honeymoon. In these instances, you’ll most likely need to pay a gift tax.
Instead, however, you might want to consider paying expensive medical or hospital bills directly as a nuptial gift. In this way, you can avoid the gift tax requirement. Again, IRS Form 709 explains this tactic further.
It’s usually a bad idea to lend someone money, even if it’s a close friend or family member. If it’s a significant amount of money, the IRS can make the situation much worse. The IRS counts interest-free loans as gifts.
Also, say you lent money to someone. However, you later decide you don’t want it back. In that case, the IRS also considers that loan a gift.
Sharing Bank Accounts
In another instance, imagine you live close to a relative. Eventually, you decide to put your money in that relative’s bank account for convenience. As part of this arrangement, you become a joint owner of the bank account.
Now, someone’s giving you the right to withdraw money from the account at any given time.
Of course, you have no intentions to touch the money that doesn’t belong to you. Still, you can do so if you desire. You have full access to the account.
From the IRS’s perspective, your relative has given you a gift. The agency will count the balance in the account toward the gifting limit. In turn, they may levy gift taxes accordingly on your kind relative.
Understanding the Lifetime Gift Exclusion
There’s another gift tax exclusion in addition to the $16,000 annual exclusion that started in 2022. Before 2022, individuals received an $11.7 million lifetime exclusion. As of 2022, however, that amount has increased to $12,060,000.
It’s important to note the IRS tracks gift exclusions per person. For example, a married couple can exclude double the amount of lifetime gifts.
It helps to think of the annual exclusion as a cup and the lifetime exclusion as a bucket. Any excess gifting will spill over into the lifetime exclusion bucket.
An Example of the Exclusion Rules
In this example, you’ve given your sibling $50,000. Now, you’ve used up your $16,000 annual exclusion. Also, you must file a gift tax return at tax time.
However, you most likely won’t have to pay gift tax. The extra $34,000 will count toward your lifetime exclusion instead.
Now, you give your sibling another $50,000 the next year. This process will repeat. You’d simply use up a portion of your lifetime exclusion.
Alternatively, imagine you don’t give any gifts during your entire life. In that case, you’d use your entire lifetime exemption against your estate when you pass away and give your assets to your heirs.
How to Avoid Gift Taxes
There are two primary ways to avoid paying gift taxes, both of which we’ve mentioned. You can gift less than $16,000 per year to recipients. Alternatively, you can gift less than $12,060,000 to people and organizations during your lifetime.
By staying under these limits, you can share your generosity while staying under the radar. However, anytime you surpass the annual limit, you must file a gift tax return. Yet, as previously mentioned, you can still avoid paying a gift tax in many cases.
Tax Tips for Gift Taxes
Today, the IRS tracks just about any kind of income you might receive. The agency monitors income so it can collect the correct amount of taxes.
Of course, this kind of monitoring is unpleasant in any form. Still, it makes sense the IRS regulates gift-giving with taxes.
There are a few ways that you can avoid paying gift taxes on the things that you give away every year. Again, most people never reach the IRS gift-giving limits.
However, if your gift-giving comes near or exceeds the mentioned limits, there are a few tactics you want to keep the mind. Let’s have a look at them.
Gift Tax and Marriage
Again, married couples have an advantage. The IRS treats them independently when it comes to the gift tax limit.
What one spouse donates or receives gets classified separately from the other spouse. It doesn’t matter whether the couple files individual or joint tax returns.
When it comes to married couples, this benefit goes both ways. You and your spouse can each give gifts of up to $16,000 per year from your joint property. In effect, you can give up to $30,000 per year to recipients.
However, you can also use this rule to gift married couples. In other words, you can give up to $16,000 in gifts to each spouse. Still, you won’t exceed the annual gift tax limit.
Getting Generous When Gifting Couples
Again, the IRS treats couples differently when it comes to gift taxes. In an extreme example, you could use this method to gift even more to a couple. You and your spouse or partner could give as much as $64,000 to a couple without incurring gift taxes.
You could give $16,000 to one member of the couple and then another $16,000 to the other. Meanwhile, your spouse or partner could do the same, all while not exceeding the gift tax limit.
Know the Gift Tax Limit
Of course, the best way to avoid the gift tax limit is to avoid the gifting amount ceiling established by the IRS. Now, that limit is $16,000. However, it usually increases annually with inflation.
You can give as many gifts as you want under the $16,000 limit without needing to pay gift tax. As soon as you go over $16,000 in gifts to an individual, however, you must file a gift tax return.
It’s also important to understand that gifting includes anything of value. The gift tax rule doesn’t apply exclusively to money.
Spread Gifts Across Years
You can also use your lifetime exclusion bucket to spread gifts out between years. This tactic helps you to avoid exceeding the $16,000 yearly gift tax limit.
It can also help you to maximize what you give. By spreading out gifts over time, you can reduce the taxes you owe on your presents.
Imagine you want to give a relative a gift of $25,000, but you don’t want to trigger a gift tax. You can give your relative $12,500 in 2022. You can then wait until 2023 to give your relative the remaining $12,500 and avoid triggering a gift tax.
The Education Gift Tax Exclusion
The method for avoiding gift taxes on education and medical expenses works much in the same way. You can avoid gift taxes on education expenses by making payments directly to an institution rather than an individual.
In this way, you can gift money for tuition costs. You can also gift money for other qualifying expenses. The most important thing to remember, however, is to pay the school and not the student.
Also, note that you cannot use this method to pay for books and supplies. These items will still count toward your annual gift limit, even if you paid the school directly.
The Medical Gift Tax Exclusion
This tactic is one of the most notable gift tax limit workarounds. You can use this method to help a friend or family member with medical expenses.
Again, however, you must pay the gift directly to the medical institution or insurance provider. You cannot pay the gift directly to the recipient even with the explicit purpose of covering medical costs. If you do so, the IRS will still count it towards your gift tax limit.
For instance, you may want to pay for the cost for a grandparent to stay in long-term care. In that case, you must work directly with the facility on billing. In this way, you can pay for your grandparent’s ongoing medical costs without worrying about exceeding the yearly gift limit.
Another Example Gift Tax Exclusion
Now, let’s drive this concept home with one more example of how the annual gift tax exclusion works. In general, you can give up to $16,000 per year in gifts without worrying about the gift tax exclusion.
However, what happens if you give more than $16,000 in cash or assets to any one person? These assets might include:
Now, you must file a gift tax return.
Points to Consider
Remember, however, you most likely won’t have to make a gift tax payment unless you’ve exceeded your lifetime gift allowance. Still, you must disclose to the IRS that you’ve exceeded the annual return limit by completing Form 709 if you pass the annual limit.
As you consider the gift tax, remember the annual limit counts per recipient. It doesn’t apply to the sum of all your gifts for the year.
You could give $15,000 to a cousin. You can then give another $15,000 to both a friend and a neighbor. No matter how many times you gift the $15,000, there’s no need for you to file a gift tax return unless you’ve exceeded your lifetime gifting amount.
As you can see, most of us won’t need to worry about gift taxes. If you’re ever fortunate enough to have plenty to give, however, you’re already a step ahead in planning your tax-related finances.
Get Smart About Your Money
Now, you know a bit more about gift taxes. Yet, there’s so much more you can learn about personal finance.
Please browse our Finance section and learn more about managing your money.