Gift Tax Explained: What It Is and How Much You Can Gift Tax-Free

What Is a Gift Tax?

A gift tax is a federal tax paid by an individual who transfers something of value to another individual without receiving something of similar value in return. Gifts can be anything of significant value, such as large sums of money or real estate, and the tax can be imposed even if the person donating never intended it to be a gift.

The Internal Revenue Service (IRS) sets limits on how much you're allowed to gift before you must file a return and before you are taxed. Sums over the annual thresholds are reportable and count toward a lifetime gift tax exemption amount. Once this generous allowance is exhausted, the gift tax becomes payable.

Key Takeaways

  • The gift tax is a federal tax levied on a taxpayer who gives money or property to someone else.
  • The gift tax ranges from 18% to 40%, depending on the size of the gift.
  • The IRS allows a lifetime tax exemption on gifts, which is adjusted yearly to keep pace with inflation.
  • Gifts that are given to spouses who are U.S. citizens, to political organizations for use by the organization, and for medical and tuition-related expenses, along with gifts valued at less than the annual exclusion amount, are excluded.
  • Gift splitting and gifts given in trust are two strategies to avoid incurring the gift tax.

How a Gift Tax Works

The federal gift tax was created to prevent taxpayers from giving money and items of value to others to avoid paying income taxes. The gift tax is applied to prevent undue hardship and to oblige donors and recipients to honor their tax liability. Donors must fill out the federal gift tax return (Form 709) and submit it along with their annual tax returns by April 15 of the year after the gift was made.

Gift tax rates are based on the size of the taxable gift and can range between 18% and 40%. The tax is only triggered on annual gifts above a certain amount, with anything below that amount being excluded from the tax. The annual exclusion is $16,000 for 2022 and $17,000 for 2023. Those limits are per recipient, meaning you could give several gifts up to $16,000/$17,000 to different people without triggering the gift tax.

If you’ve given a gift that exceeds the annual exclusion maximum but is still under the lifetime maximum, then you must report the gift but you won't be liable to pay tax on it.

The lifetime exclusion is the total sum you can give over the course of your life. Adjusted annually for inflation, this exclusion is $12.06 million in 2022 and $12.92 million in 2023. The donor can gift up to this amount before the gift tax is applied. Annual limits still apply, though, which means the lifetime exemption applies to amounts over and above annual exclusions.

Special Considerations

Form 709 includes calculations for how much gift tax is owed. But filing Form 709 doesn’t necessarily mean that you pay the gift tax.

If you’ve given a gift that exceeds the annual exclusion maximum ($16,000 in 2022 and $17,000 in 2023) but is still under the lifetime maximum ($12.06 million in 2022 and $12.92 million in 2023), then you won’t trigger the gift tax—but you still must report the gift.

There are also a lot of exceptions to the gift tax. The following items are generally not subject to gift tax:

  • Gifts to the donor’s spouse. An unlimited amount can be gifted tax-free if the spouse is a U.S. citizen. If the spouse is not a U.S. citizen, then tax-free gifts are limited to an annually adjusted value—$164,000 in 2022 and $175,000 in 2023.
  • Gifts to a political organization for its use
  • Medical and educational expenses—payments made by a donor to a person or an organization, such as a college, doctor, or hospital
  • Gifts to a charitable organization
  • Gifts that are valued at less than the annual gift tax exclusion rate for that year

Gift Tax Strategies

There are strategies for avoiding or minimizing the gift tax. These include:

Gift Splitting

Being married allows you to double your gifts. Remember, the annual exclusion applies to the amount of gift that an individual can give a recipient. That means that even if they file a joint tax return, spouses can each give $16,000 in 2022 or $17,000 in 2023 to the same recipient—effectively raising that gift to $32,000/$34,000 in a year without triggering the gift tax.

This strategy is known as gift splitting and enables wealthy couples to give substantial annual gifts to children, grandchildren, and others. This gift can be on top of, say, tuition paid directly to a grandchild’s school or college—which is exempted outright from the gift tax.

Gift in Trust

Donors can give gifts in excess of the annual exclusion without paying taxes by establishing a special type of trust—the Crummey trust is the usual arrangement—to receive and distribute the funds.

The gift tax exclusion usually doesn’t apply to money distributed by trusts. But a Crummey trust allows the beneficiary to withdraw the assets within a limited time period—say, 90 days or six months. This gives the beneficiary what the IRS calls a present interest in the trust—and this sort of distribution can qualify as a nontaxable gift. Of course, the recipient can only take out a sum equal to the gift given to the trust.

You can gift more than the annual exclusion without reducing your lifetime gift tax exemption under certain 529 college savings plan contributions. In these cases, you report this single large gift as being spread over five years on your tax return and file the form each year. The only catch is that you can’t make any additional gifts to the same recipient during this period. If you do, then it will be applied to your lifetime exclusion.

Examples of the Gift Tax

Here are a couple of examples of how the gift tax works.

Let's say Taxpayer A gave $100,000 to five individuals in 2022—$20,000 to each. Because the annual exclusion limit is $16,000 per person, $20,000 of the total amount given is not excluded and reduces the lifetime exemption amount. So, after making these gifts, Taxpayer A has $12.04 million remaining of the exemption to give before paying gift taxes.

Here's another example. In 2022, a grandmother who wants to encourage her granddaughter’s education paid $20,000 for a year’s tuition. That same year, she also gave the young woman $16,000 for books, supplies, and equipment. Neither payment is reportable for gift tax purposes—the tuition is excluded outright, and the $16,000 is the maximum allowed under the annual exclusion.

If Grandma had sent the future physician $30,000 and the young woman already paid the school, then the grandmother would have made a reportable (but not taxable) gift of $14,000 ($30,000 less the annual exclusion of $16,000), which would reduce her $12.06 million lifetime exclusion by $16,000.

How Much Is the Gift Tax?

The gift tax is applied on a sliding scale, depending on the size of the gift. It only kicks in on gifts above and beyond a certain threshold established by the IRS. First, a flat amount is assessed; additional tax is then levied at a rate that ranges from 18% to 40%.

How Much Can I Gift Someone Tax-Free?

You can give someone up to $16,000 for the 2022 tax year and $17,000 for the 2023 tax year. Anything above those amounts will eat into your lifetime gift allowance ($12.06 million in 2022 and $12.92 million in 2023), which, if exhausted, will trigger the gift tax.

Does the Receiver of a Gift Pay Tax?

The person receiving a gift usually is not required to pay gift tax. The recipient can opt to do so, though, especially if the amount would put the donor over their lifetime gift tax exclusion.

How Much Can I Gift My Child?

You can gift your child or grandchild the same amount that you can gift other relatives or friends without incurring the gift tax, namely:

  • $16,000 in 2022 and $17,000 in 2023 per recipient
  • $12.06 million in 2022 and $12.92 million in 2023 over the course of your lifetime

The IRS regularly adjusts these maximums for inflation. Since the $16,000 and $17,000 thresholds apply to one donor, a married couple can each give that amount to the same child, resulting in an annual gift of $32,000 and $34,000, respectively.

The Bottom Line

The gift tax is a federal levy that applies when you give to another individual or individuals, without charge, a sum of cash or assets—either tangible or intangible—that have intrinsic worth. It is imposed on the donor rather than on the receiver.

However, the gift tax has been devised in such a way that very few people end up actually paying it. Numerous types of gifts are exempted, including anything to a spouse. In addition, you can give an eight-figure sum over the course of your life before the gift tax is triggered—and even then, it applies to the amount above that threshold.

Article Sources
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