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Tuesday, March 21, 2023
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.
“It’s better to give than to receive,” according to the old adage. But many people aren’t aware that there could be tax ramifications to giving away money or assets to others.
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.
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. In 2022, you only have to file a gift tax return and possibly pay the gift tax if you give away cash or property that’s valued at more than $16,000 per year. If you’re married and you and your spouse file a joint income tax return, together you can give away up to $32,000 per year gift-tax free.
Note that this annual exclusion is per gift recipient. So you could give away $16,000 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.
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 $16,000 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 2022, the lifetime gift tax exclusion is $12.06 million per person, or $24.12 million per married couple. If you gave $60,000 to a single person in one year, for example, the $45,000 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.
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 April 15 after the year you exceeded the annual exclusion. If you receive gifts over $100,000 from a nonresident alien or foreign estate, you will need to file Form 3520 to report the receipt of the foreign gift. The filing deadline for Form 3520 is also April 15 following the year of receipt of the foreign gifts over $100,000.
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 $16,000 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.
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.
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.
If you’re interested in planning for these sizable financial gifts, consider signing up for Empower’s free financial tools. Millions of people use this technology to see all of their financial accounts in one place in order to manage their money and plan for long-term goals.
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The Currency is a personal finance publication powered by Empower and run by a team of writers and editors. We deliver the financial news and views you need to know for life, work and play.
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