What Is a Gift Tax?
A gift tax is a tax that is imposed on the transfer of money or property from one person to another. The federal government levied the tax and enforced it through the Internal Revenue Service (IRS).
The gift tax is intended to prevent people from avoiding the estate tax by giving their assets to their heirs before they die. The gift tax applies to cash and property, typically imposed on the donor, not the recipient.
What Is Considered a Gift?
For tax purposes, a gift is defined as any transfer of money or property from one person to another without receiving anything of equal value (or fair market value) in return.
What Is the Annual Gift Tax Limit for 2022 and 2023?
For the tax year 2022, the annual gift tax exclusion is $16,000 per person ($17,000 in 2023). This means you can give up to $16,000 ($17,000 in 2023). to any person in a single year without paying any gift tax.
For example, if you give your friend $17,000 for his birthday in 2023, you will not have to pay any gift tax. If you give him $20,000, however, you will be required to pay gift tax on the $3,000 that exceeds the annual exclusion.
The annual gift tax exclusion is indexed for inflation, increasing yearly. The exclusion was $15,000 in 2021.
Spouses can combine their annual exclusions to give a total of $34,000 to any one person without triggering the gift tax.
To file for gift taxes owed, you will need to fill out Form 706.
Lifetime Gift Tax Exemption 2022 and 2023
Another way to avoid paying gift tax is to take advantage of the lifetime gift tax exemption. The lifetime gift tax exemption is a one-time exclusion that allows you to give up a certain amount of money or property during your lifetime without having to pay any gift tax.
For the tax year 2022, the lifetime gift tax exemption is $12.06 million ($12.92 million in 2023). This means you can give away up to $12.06 million ($12.92 million in 2023) during your lifetime without paying any gift tax.
Using our example above, if you give your friend $20,000 for his birthday, the $17,000 would be cleared from any gift tax. You will need to file a gift tax return for the remaining $3,000, but you can choose not to pay any tax on that amount.
You can make use of the lifetime gift exclusion instead. Using the lifetime cap of $12.92 million million, simply subtract the remaining $3,000. This leaves you $12.917 million as the remaining lifetime cap.
Filing a gift tax return is important in order to keep track of lifetime exclusion. Any remaining amount to that limit can be used against estate taxes in the event of a person's death.
The lifetime gift tax exemption is also indexed for inflation, increasing yearly. The exemption was $11.7 million in 2021.
Gifts Exempt from Gift Tax
Some gifts are exempt from gift tax and do not count towards the annual or lifetime gift tax limits. The following are the gifts exempt from gift tax:
Gifts Not Exceeding the Limit
Any sort of asset that does not exceed the annual or lifetime gift tax limits is exempt from gift tax. For example, if you give your friend $17,000 for his birthday, you will not have to pay any gift tax.
Tuition Fees and Education Payments
Gifts made to cover tuition fees and other education-related expenses are exempt from gift tax. The payments must be made directly to the educational institution and not to an individual.
Charitable Donations
Gifts made to qualified charitable organizations are exempt from gift tax. The gifts can be in the form of cash, property, or even stocks and bonds.
Medical Expenses
Gifts made to cover medical expenses are exempt from gift tax. The payments must be made directly to the medical provider and not to an individual.
Political Contributions
Gifts made to political organizations and candidates are exempt from gift tax. The gifts can be in the form of cash or kind.
Gifts to Spouses
Gifts made to your spouse in any amount as long as they are a U.S. citizen are also free from gift tax. If they are not a citizen of the country, a $164,000 annual exclusion limit will apply for the year 2022 ($175,000 for 2023).
Calculating the Gift Tax
Gift tax rates are marginal, meaning the tax rate increases as the value of the gift increases. But remember that gift tax will only be due once you exceed your lifetime exclusion limit.
So, if a person who has surpassed the lifetime limit decides to gift a person other than his spouse or dependent, taxes will be owed on the gifted amount.
To calculate the gift tax, you will need to determine the value of the gift and then find your marginal tax rate. The marginal tax rate for gifts is currently 40%.
Below is a table showing the tax brackets for federal gift tax rates applicable for 2023.
How to Avoid the Gift Tax
As mentioned above, the gift tax can be avoided by using your annual and lifetime exclusion limits.
Another way to dance around the gift tax is by gift splitting. Gift splitting is a method by which a married couple can avoid paying gift tax on large gifts. This can be done by each spouse gifting half of the total amount to the recipient.
For example, if you want to give your daughter $34,000, you and your spouse can each gift her $17,000.
There is also the option of creating a trust fund. You can place money or assets in a trust fund and name someone as the beneficiary.
The trustee will then manage the fund and dispense the money to the beneficiary as per your instructions. This method can be used to avoid gift taxes and estate taxes.
Final Thoughts
The gift tax is levied on the transfer of tangible or intangible property that has intrinsic value. The donor is the party responsible for paying the gift tax, not the receiver.
The annual gift tax limit ($16,000 in 2022 and $17,000 in 2023) is the maximum amount that can be gifted in a year without having to pay gift taxes. The lifetime gift tax exemption ($12.06 million in 2022 and $12.92 million in 2023) is the total amount that can be gifted over the course of a person's lifetime without having to pay gift taxes.
Certain gifts are exempt from gift tax, such as payments intended for school expenses and medical expenses, as long as they are given directly to the institution and not to an individual. Gifts made to charitable organizations, political organizations, spouses, and dependents are also exempt from gift tax.
Gift tax can be avoided by using your annual and lifetime exclusion limits or by gift splitting. You can also create a trust fund to avoid gift taxes and estate taxes.
FAQs
1. What is the difference between a gift tax and an inheritance tax?
An inheritance tax is levied on property inherited from a deceased person, while a gift tax is levied on the transfer of property from a living person.
2. What is the difference between gift and estate taxes?
An estate tax is levied on all property owned by a person at the time of their death, while a gift tax is only levied on gifts made during a person's lifetime.
3. How much is the gift tax?
The gift tax will depend on the size of the gift. It is only due when it exceeds the exclusion limits. Once the limit is exhausted, a gift tax rate will be applied to the amount exceeding the exclusion limit. The tax rate starts at 18% and goes up to 40%.
4. Who pays the gift tax?
The donor is responsible for paying the gift tax and not the receiver.
5. How do I declare the gift tax?
The gift tax must be reported on Form 709, which must be filed with the IRS. This should be submitted along with a donor's annual tax return by April 15 of the year after the gift was given.
