It’s giving season!
Giving Tuesday is a day set aside to be generous toward the non-profit organizations in our communities. Besides the obvious blessing of giving money to worthy organizations, there is the added financial benefit of a tax deduction.
But what about gifting money to a friend or family member? Of course, there is no tax deduction, but what about the gift tax? Should you be worried about paying taxes when giving or receiving gifts?
If you’ve ever had this question, you’re not to blame—the gift tax is one of the most misunderstood concepts in our tax code.
Yes—the gift tax is a real thing. No—most people don’t have to worry about it. Before I explain, let’s see why the gift tax exists and what you can do to avoid it.
Why would the IRS tax a gift?
It’s helpful to understand the spirit behind the gift tax. Gift tax is closely related to estate taxes. If you die with a large amount of assets (called an estate), your heirs might owe tax on the estate. Currently, the tax code allows a very large amount ($12,060,000 per person) to be exempt from estate tax. This is why most people don’t have to worry about estate taxes. But this exemption amount can always change and is scheduled to expire in 2025.
Why wouldn’t someone with a very large estate just give away assets to their heirs while still living to circumvent the estate tax? This is why the gift tax exists—to prevent you from avoiding estate taxes by giving away your wealth to your heirs while you are still living.
It’s important to note that gift tax doesn’t just apply to cash gifts. According to the IRS, a gift is a transfer of an asset where “full consideration is not received in return” (i.e., wasn’t purchased for fair market value).
How to use the gift tax exclusion
Thankfully, it’s pretty easy to avoid taxes on gifts.
To give a gift without any additional tax planning or forms, the IRS has an annual exclusion of $16,000 per giver/receiver ($17,000 for 2023). This means you don’t have to report a gift if it is under $16,000. Even if you give $16,000 to multiple people, that’s fine, as long as it doesn’t exceed $16,000 per “receiver”.
But what about a gift exceeding $16,000? If this happens, the giver (not the receiver) needs to file IRS Form 709. However, that most likely still does not mean taxes are owed!
Remember how the estate exemption is really high? The $12,060,000 exemption applies to gift and estate taxes combined. Any amount that is used for gifts will reduce the amount available for estate tax.
Here’s how this works:
If you gave a $76,000 gift to your child in 2022, you need to report this on IRS Form 709 because it’s higher than the $16,000 annual exclusion. The $16,000 is still excluded, but the $60,000 excess will lower your lifetime gift/estate exemption. So now your lifetime gift/estate tax exclusion goes from $12,060,000 to $12,000,000.
Again, no taxes are owed at this point. But for someone with a very large estate, it can affect your future estate tax.
Other ways to avoid gift tax
A married couple can give away even more while still adhering to the annual exclusion. For example, if a married couple wanted to give a large gift to their son and his wife, they could give a total of $64,000 ($16,000 from each of them to their son and $16,000 to their daughter-in-law). Form 709 might need to be filed to track the “split gift”, but these gifts would not eat into their lifetime exclusion.
Another strategy to accelerate the amount of gifting is by utilizing 529 Plans. The IRS allows you to “front-load” five years’ worth of giving at once. Let’s say a grandparent wanted to give money to his grandchild’s 529 Plan. He can give all five years ($16,000 x 5 = $80,000) all at once without using any of his lifetime exemption. This strategy also requires filling a Form 709, and the IRS provides instructions here.
Go ahead and make that gift!
As you can see, the gift tax is not as bad as it seems. While most people aren’t affected by it, you still need to know when a gift is large enough to trigger additional tax planning. Even when the annual exemption threshold is exceeded, it’s nice to know that most people still won’t pay tax on the gift.