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The gift tax is an item that will not be on the radar of most taxpayers. However, in special circumstances, it could impact your taxes.
What is the gift tax?
The gift tax imposes a tax on large gifts, preventing large transfers of wealth without any tax implications. It is a transfer tax, not an income tax. Ordinary monetary and property gifts are unlikely to be impacted by this tax, since the yearly limit for 2021 is $15,000 per giver and per recipient.
A single person who gives several $15,000-or-less gifts to different recipients in a year, for example, won’t be impacted by the gift tax and won’t have to file a gift tax return. In addition, the amount of people with the capacity to give more than this amount is limited, so few people have to consider whether they need to file a gift tax return.
An important consideration, however, is educating yourself on what counts as a gift. If, for instance, you sell a house for substantially less than the IRS would deem its “fair market value” (perhaps as a favor to a family member or friend), the difference between the market value and your price is considered a gift and may need to be reported on a gift tax return if it exceeds $15,000 per giver and per recipient.
What is the gift tax rate?
The gift tax only applies once you surpass your exclusions. In 2021, the IRS made the lifetime amount $11.7 million for a single taxpayer or $23.4 million for a married couple. After giving out money or property exceeding this threshold, your gift tax rate will be between 18 percent and 40 percent, depending on how far your cumulative gifts eclipse it. You will also need to fill out IRS Form 709 with your return.
How does the gift tax work?
Should you find yourself in a position to give more gifts than $15,000 a year per recipient, there are still a few more ways you could be exempt from payment.
While you’ll still have to file a return that declares your gift because it’s above the $15,000 annual exemption, the lifetime exemption still applies. Say you gifted $25,000 to a family member in 2020. That gift applies to your $15,000 annual exclusion, and the remaining $10,000 applies to your lifetime exclusion of $11.7 million for a single taxpayer or $23.4 million for a married couple. Those lifetime figures are drawn from the estate tax exemption, since the lifetime exemption counts against the combination of taxable gifts (those exceeding the annual exclusion amount of $15,000 per giver per recipient) made during life and from your estate after death.
You can see how most people, even if they do need to track and declare large gifts, still won’t be liable for gift tax.
There are other kinds of gifts that are exempted entirely, as well, including:
- Gifts to directly pay for medical or educational expenses.
- Gifts to a political organization to be used by the organization.
- Gifts to one’s spouse (some limits apply if the spouse is not a U.S. citizen).
- Charitable giving.
Who has to pay the gift tax?
Fortunately for the gift recipient, the giver pays the gift tax if any is due. If the giver is in a position to owe gift tax, they won’t require the recipient to pay the tax alongside receiving the gift.
In general, very few people pay the gift tax, since even large five- and six-figure gifts only count toward the lifetime exemption. The most common time gift taxes are paid is when it’s tied to an estate after someone passes away, since very large estates can exceed the multimillion-dollar limit.
The bigger question is whether you need to file a gift tax return, which reports large gifts that count against your lifetime exemption to the IRS. Again, while this is fairly rare, knowing that you owe the IRS some paperwork is important. If significant gifting to family and/or friends is important to you, it may be worth considering spreading out gifts to children, grandchildren or other family members or friends so that you don’t exceed the $15,000 per person a year limit, which saves you from a little tax return complexity.
How can you avoid the gift tax?
Pretty much everyone can avoid having to pay the gift tax, but in the event that you are in a position to give extensively, here are some important tips:
- If you are part of a couple, remember that you can each give $15,000 a year to the same recipient, effectively giving $30,000 to one recipient without breaking past the annual exemption. This is referred to as “gift splitting.” Married couples who plan to do this should still file a gift tax return (even if the gift won’t be taxable) so they can properly report and elect their gift splitting.
- Spread out gifts or find ways to pay directly for medical or educational expenses, rather than gifting funds for any purpose.
- Factor into your estate plan how much you’ve given or plan to give in your lifetime plus what you expect to give through your estate, since the gift tax lifetime exemption also includes anything you leave in your estate after you pass away.
- Talk with your accountant, financial planner or wealth management team about how you can distribute your assets in ways that won’t trigger gift tax. Large and complex financial, business or real estate holdings can generate big tax bills without someone helping you work out the logistics.
The good news is that most people aren’t affected by the gift tax or the gift tax limits and aren’t required to disclose smaller gifts to the IRS.
However, if you know that you’re making what could be counted as a large gift — such as extending an interest-free loan or giving someone money now that they will later use for college, but haven’t yet spent — make sure you find out if it will require you to at least file a gift tax return.