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Wednesday, February 21, 2024

Gift tax: What is it and how does it work?

Gift tax: What is it and how does it work?

Key takeaways

Gift tax is assessed on transfers of cash or property valued above a certain threshold. The gift tax is paid by the giver of the gift.

12.22.2023

​​“It’s better to give than to receive” — so goes the old adage. But many people aren’t aware that there could be tax ramifications to giving away money or assets to others.

What is gift tax?

A federal tax called the gift tax is assessed on transfers of cash or property valued above a certain threshold. Gift tax is paid by the giver of money or assets, not the receiver. The good news is that this threshold is so high that few people end up having to pay the gift tax.

These thresholds are referred to as exclusions. There are two separate gift tax exclusions: an annual exclusion and a lifetime exclusion.

Annual gift tax exclusion

As the name implies, the annual gift tax exclusion is the amount of money you can give away each year before the gift tax kicks in. If you give away cash or property that’s valued at more than the annual limit, you typically need to file a gift tax return and possibly pay the gift tax. If you’re married, and you and your spouse file a joint income tax return, together you can give away up to double the individual limit per year gift-tax free.

The gift tax limit is $17,000 in 2023 and $18,000 in 2024. Note that this annual exclusion is per gift recipient. So you could give away the limit to several different people in a single year and still not have to file a gift tax return and possibly pay the gift tax. Also, you and your spouse can generally give as much as you like to each other without triggering any gift tax ramifications.

Lifetime gift tax exclusion

The lifetime gift tax exclusion is the amount of money you can give away during your lifetime before the gift tax kicks in. It is an additional exclusion amount that’s added to the annual gift tax exclusion. So if you give away more than the annual limit in one year to a single person, the lifetime gift tax exclusion will kick in. Think of these like buckets: If you fill up your annual gift tax exclusion bucket, the excess gift amounts will spill over into your lifetime gift tax exclusion bucket.

In 2023, the lifetime gift tax exclusion is $12.92 million per person, or $25.84 million per married couple. So for example, if you give $60,000 to a single person in 2023, the $43,000 that’s above your annual exclusion amount would be applied to your lifetime exclusion.

As you can see, you would have to give away a lot of cash and property before you end up having to pay gift tax. However, you will have to file a gift tax return if you give away more than your annual gift tax exclusion in any one year. This return is used to help you and the IRS keep track of your lifetime gift tax exclusion.

2023 gift tax rate

If your gifts exceed these exclusion amounts, you may have to file a gift tax return and pay the gift tax. The gift tax rates in 2022 range from 18% to 40%, depending on the amount by which your gifts exceed the exemptions.

The gift tax return is due on Tax Day after the year you exceeded the annual exclusion.

How can you avoid gift tax?

To avoid having to file a gift tax return and possibly even pay the gift tax, be careful that you don’t inadvertently exceed your annual gift tax exclusion in any one year. For example, suppose you want to help pay for your grandkids’ college expenses so you contribute $20,000 to each of their 529 college savings plans. You’ll now have to file a gift tax return reporting these gifts.

Or maybe you decide to pay for your child’s wedding or foot the bill for their honeymoon. These would each be considered gifts, so if you spend more than $17,000 on either of them, you’ll have to file a gift tax return. Spreading out gifts or finding ways to pay directly for medical or educational expenses, rather than gifting funds for any purpose, is another way to potentially avoid paying gift tax.

Gift tax FAQs

Q: What is the gift tax?

A: The gift tax is a tax assessed on transfers of cash or property valued above a certain threshold, which is referred to as an exclusion.

Q: Who pays the gift tax?

A: The gift tax is paid by the giver of the gift, not the recipient.

Q: What is the gift tax rate?

A: The gift tax rates range from 18% to 40%, depending on the amount by which your gifts exceed the exemptions.

Q: How can I avoid the gift tax?

A: The best way to avoid paying the gift tax is to keep your annual and lifetime gifts below the exclusion amounts.

Seek professional assistance

The details of gift tax planning can be complex, so be sure to consult with a tax professional for advice and guidance in your specific situation.

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