Most of the time, you probably don’t even think about taxes in connection with gifts. The only tax you’ll pay on that sweater for Grandma is the sales tax when you purchase it. However, when you give large amounts of your estate to a friend or family member, there are a few tax limitations you’ll have to consider.
The gift tax doesn’t kick in until you’re giving large amounts of money away—that is, millions. But knowing how much you’ll need to report, and keeping track of the money you give, can help you plan for the future.
The Gift Tax
Taxes on gifts can range from 18% to 40% of the gift’s value, paid by the giver. This includes both cash gifts and gifts of valuables or real estate. But you’ve probably never had to pay any amount on a gift. The reason is that you are exempted three different ways: an annual exemption, a lifetime exemption, and exemption for certain types of gifts.
The annual exemption for 2022 is $16,000. That means you are completely exempt if you don’t give more than $16,000 to any one individual. You can give more than that to separate people, or you and your spouse can each give $16,000 to the same individual. If you don’t meet that limit, you don’t have to pay tax or even report the gift.
Even if you exceed this limit, though, you still won’t owe any taxes until you reach your lifetime exemption. The lifetime exemption is, at the moment, $12.06 million. Unlike the annual exemption, this isn’t limited to one recipient. If the total gifts you’ve ever given in your life (not counting exempt gifts, as above and below) add up to $12.06 million, you’ll start to owe taxes. This limit is subject to change, and it is scheduled to be cut in half in 2025, barring future legislation. So it’s good to keep track of your total gifts, especially if you intend to use gifts as part of your estate plan.
Exempt Gift Types
Lastly, certain types of gifts are completely exempt from tax and reporting, no matter how large they are:
- Gifts to your spouse, if they are a US citizen
- Gifts to a political organization
- Charitable donations
- Medical or educational costs paid for another person
So, if you want to give a large amount of money to, for instance, a grandchild for their college, you can. If you pay the money directly to the school, you don’t even need to report it. However, if you give to a 529 account, or if you give your loved one money to pay for books or living expenses at college, the usual exemptions apply.
Strategic Gifting as Part of Your Estate Plan
Few people are generous enough to have to pay gift taxes on their usual Christmas and birthday presents. But as you grow older, you might start to think of your worldly goods differently. You can’t take any of it with you. Many people choose to start divesting their estate while they’re alive, to share their blessings with their heirs and save on estate tax. After all, neither the giver nor the recipient has to pay any taxes on a gift under the limit.
That’s when gifts tax might come in. If you try to avoid estate taxes by giving away your possessions while you’re alive, you’ll have to keep your lifetime limit in mind. If your estate is over that limit, you will have to pay taxes on the excess.
One way people distribute their estate to their heirs is by using trusts. But by placing the funds you want to give your family in a trust, they aren’t gifts anymore and are governed by the rules of the trust. That generally means the money is taxed, and often at higher rates than regular income. If you want to avoid this tax penalty, ask your financial advisor or attorney about a Crummey trust. This is a trust which gives the grantee a present interest in the money, which they can withdraw within a certain amount of time. Funds you give through this kind of trust can be untaxed if they meet one of the other gifts tax exclusions.
Get Expert Advice
If you give large amounts to your family, or if you’re considering how best to pass on your possessions in your estate plan, a financial advisor can help. We can connect you with an expert advisor who can help you find the right strategies for your situation. Contact us today.