If you make large enough gifts to relatives or friends, you might owe the federal gift tax. Here are the basics on how the gift tax works.
• Givers, not receivers, pay the federal gift tax, but you can give away up to $12.06 million in cash or other assets during your lifetime (tax year 2022) without triggering the gift tax.
• If you’re married, your spouse is entitled to give another $12.06 million (tax year 2022) in lifetime gifts without incurring a gift tax.
• You can give up to $16,000 (tax year 2022) per person per year to as many people as you like without those gifts counting against your $12.06 million lifetime gift tax exemption.
• Gifts to IRS-approved charities, to your spouse (assuming they are a US citizen), to pay another person’s medical expenses, and to cover another person’s tuition expenses are all exempt from the gift tax and from the annual limit.
What is the gift tax?
The gift tax is a federal tax that the IRS imposes on people that gift property. The gift tax is applicable when you receive nothing in exchange, or receive compensation that’s less than the property's full value.
This can include, but isn’t limited to:
- Real estate
- Interest-free loans
Note that whether or not you intend for the property to be a gift, the gift tax applies if you don’t receive full compensation for the property that’s been given.
Which gifts are exempt from the federal gift tax?
The following types of gifts are some examples of gifts that are exempt from the federal gift tax. You can make unlimited gifts in these categories without any gift tax or estate tax consequences and without having to file gift tax returns:
- Gifts to IRS-approved charities
- Gifts to your spouse (assuming they are a US citizen)
- Gifts covering another person’s medical expenses, as long as you make the payments directly to medical service providers
- Gifts covering another person’s tuition expenses, as long as you make payments directly to the educational institution. Payments for room and board, books, and supplies don’t qualify for this exception, but you can cover those costs by making a direct gift to the student under the annual exclusion.
How much is the gift tax?
The gift tax rate only applies to gift amounts exceeding the lifetime exclusion limit, which is $12.06M for the 2022 tax year.
The IRS gift tax rate is a marginal rate, meaning the rate increases as the total amount you’ve gifted for the year increases. This is similar to how income tax rates work.
The gift tax is applied based on brackets. For example, $0 to $10,000 over the lifetime exclusion limit is taxed at the lowest gift tax rate, while each incremental bracket is taxed at a higher and higher tax rate.
The gift tax rate currently ranges up to 40%, with anything gifted over the lifetime exclusion limit being taxed at 40%.
Who pays the gift tax?
The gift tax only kicks in after lifetime gifts exceed $12.06 million in 2022.
The first thing to know about the federal gift tax is that gift givers—not gift recipients—have to pay it. Thankfully, you won’t owe the tax until you’ve given away more than your lifetime limit plus the annual limit in cash or other assets during your lifetime.
- The lifetime exclusion was raised to $12.06 million in 2022.
- If you’re married, your spouse is entitled to a separate $12.06 million in 2022.
So, actually owing the gift tax isn't a concern for most folks. But you may still have to file gift tax returns even though you don’t owe any taxes.
How much can you give tax free?
The annual gift tax exclusion provides additional shelter.
The annual federal gift tax exclusion allows you to give away up to $16,000 each in 2022 to as many people as you wish without those gifts counting against your $12.06 million lifetime exemption. (After 2022, the $16,000 exclusion may be increased for inflation.)
Say you give two favored relatives $21,000 each in 2022 and give another relative $10,000. The $21,000 gifts are called taxable gifts because they exceed the $16,000 annual exclusion. But you won’t actually owe any gift tax unless you’ve exhausted your lifetime exemption amount.
- Assuming you haven’t, the two taxable gifts simply reduce your lifetime exemption by $5,000 for each gift or $10,000 total for the two gifts.
- ($21,000 - $16,000) x 2 = $10,000.
- The other gift of $10,000 is ignored because it’s below the $16,000 annual exclusion for 2022.
If you give three individuals $16,000 each in 2022, these gifts are ignored because no single gift exceeds the annual exclusion.
How does gift tax relate to estate tax?
You have a $12.06 million federal estate tax exemption for 2022. You can leave up to that amount to relatives or friends free of any federal estate tax. If you’re married, your spouse is entitled to a separate $12.06 million exemption.
Gifts made during your lifetime can reduce your taxable estate by moving assets out of your ownership and therefore out of your estate. However, gifts in excess of the annual exclusion also reduce your estate tax exemption.
- In the earlier examples, the two $21,000 taxable gifts made in 2022 would reduce your estate tax exemption by $10,000 to $12,050,000 ($12,060,000- $10,000).
- The separate $10,000 gift in 2022 and the three $16,000 gifts in 2022 wouldn't reduce your estate tax exemption.
Bottom line: Making annual gifts up to the annual exclusion is a good way to reduce your taxable estate without any negative side effects.
TurboTax Tip: You and your spouse (if you’re married) can each contribute up to $16,000 per year to a 529 college savings plan for a future student without decreasing your lifetime gift tax exemption. You can even make a lump-sum contribution in a single year and treat it as though it was made over five years for gift tax purposes, thanks to a special IRS rule.
Are 529 contributions subject to gift tax?
Contributions to a 529 college savings plan are gifts to the future student. However, a special rule allows you to make a lump-sum contribution in a single year and treat it as though it was made over five years for gift tax purposes.
For example, you can contribute $80,000 (5 years x $16,000) in 2022 to jump-start a 529 college savings account for your child. If you’re married, your spouse can do the same.
- You can spread the gift over 2022-2025 without incurring any gift tax and without reducing your $12.06 million lifetime gift tax exemption or your $12.06 million estate tax exemption.
- Your spouse can spread their $80,000 gift over five years as well.
The only caveat: You can’t make any additional gifts to the same recipient during those years without using part of your $12.06 million exemption.
Do you need to file a gift tax return?
If you make a taxable gift (one in excess of the annual exclusion), you are required to file Form 709: US Gift (and Generation-Skipping Transfer) Tax Return.
- The return is required even if you don’t actually owe any gift tax due to the $12.06 million lifetime exemption.
- The return is due by the tax filing deadline, typically April 18, 2023, of the year after you make the gift—the same deadline as Form 1040.
- If you extend your Form 1040 tax return filing to October 15, the extended due date also applies to your gift tax return.
If you’re married, you can’t file a joint gift tax return. Each spouse needs to file a separate return if they make any taxable gifts. You can, however, choose to “split” gifts with your spouse. Making a split gift allows you to take advantage of your annual gift tax exclusion plus your spouse’s exclusion for a gift that is made entirely by you.
For example, say you gave $32,000 to your child in 2022. By treating it as a split gift, you can completely shelter the gift with your $16,000 exclusion plus your spouse’s $16,000 exclusion.
- That way, no gift tax is due.
- The gift doesn't reduce the $12.06 million lifetime gift tax exemption in effect for 2022 or the estate tax exemption for you or your spouse.
If you choose to make a split gift, you need to file Form 709, and your spouse must consent to the arrangement.
A bigger story
This article only covers the basics of federal gift taxes. For more information, see IRS Publication 950: Introduction to Estate and Gift Taxes. Also see the instructions for Form 709.
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