What is the gift tax?
The gift tax is a federal tax that the IRS imposes on people that gift property. The gift tax is applicable when you receive nothing in exchange or receive compensation that’s less than the property’s full value. When a person gives money or property to someone other than their spouse or dependent, they may be required to pay gift tax. This federal excise starts at 18% and can reach up to 40% on certain gift amounts. The responsibility for paying the tax typically lies with the donor, not the individual receiving the gift. While recipients don’t face any immediate tax consequences, they may have to pay capital gains tax if they sell gifted property in the future.
This can include, but isn’t limited to:
- Cash
- Real estate
- Art
- Interest-free loans
- Vehicles
Note that whether or not you intend for the property to be a gift, the gift tax applies if you don’t receive full compensation for the property that’s been given.
Which gifts are exempt from the federal gift tax?
Fortunately, several gift tax exemptions can be used to avoid paying the tax. The most well-known exemption is the annual gift tax exclusion. This is a set dollar amount you can give each year that isn’t subject to the tax. (The amount is adjusted for inflation each year, more on this later.) And you can give up to that amount to as many people during the year as you want. If you’re married, your spouse can also give up to the same amount – even to the same people who receive a gift from you.
Other gift tax exemptions may apply, too. The following types of gifts are some examples of gifts that are exempt from the federal gift tax. You can make unlimited gifts in these categories without any gift tax or estate tax consequences and without having to file gift tax returns:
- Gifts to charities approved by the IRS
- A gift to your spouse, if they’re a U.S. citizen
- A gift to cover someone’s education tuition, if paid directly to the educational institution (does not cover room and board, books or supplies)
- Gifts to cover someone’s medical expenses, if paid directly to the medical facility
- A gift to a political organization
What is the Annual Gift Tax Exclusion and how does it work?
Currently for 2023, you can give any number of people up to $17,000 each in a single year without incurring a taxable gift ($34,000 for spouses “splitting” gifts. The recipient typically owes no taxes and doesn’t have to report the gift unless it comes from a foreign source.
The US Internal Revenue Service has announced that the annual gift tax exclusion is increasing in 2024 due to inflation. The exclusion will be $18,000 ($36,000 for spouses “splitting gifts”) per recipient for 2024.
Here’s an example: If you’re married and have two married children and four grandchildren, you and your spouse can give up to $34,000 in 2023 ($36,000 in 2024) to each of your kids, their spouses, and all the grandchildren without even having to file a gift tax return or pay any tax. That’s $272,000 ($288,000 in 2024) in tax-free gifts. Just remember that the $17,000/$34,000 ($18,000/$36,000 in 2024) limit is an annual limit. So, you must make your gifts before December 31 each year (gift checks must also be deposited by that date).
What if you exceed the annual gifting limits – Lifetime Gift Limit?
If your gift exceeds $17,000 ($18,000 in 2024) to any person during the year, you must report it on a gift tax return (IRS Form 709). Spouses splitting gifts must always file Form 709, even when no taxable gift is incurred. Once you give more than the annual gift tax exclusion, you begin to eat into your lifetime gift and estate tax exemption.
You have a $12.92 million federal estate tax exemption for 2023. The $12.92 million exemption applies to gifts and estate taxes combined—any portion of the exemption you use for gifting will reduce the amount you can use for the estate tax. The IRS refers to this as a “unified credit.” Each donor (the person making the gift) has a separate lifetime exemption that can be used before any out-of-pocket gift tax is due. In addition, a couple can combine their exemptions to get a total exemption of $25.84 million.
Starting January 1, 2024, the federal lifetime gift and estate tax exemption amount will increase to $13.61 million per person. This increased exemption amount means that individuals can transfer up to $13.61 million tax-free during their lives or at death, and married couples can transfer up to $27.22 million. It also means that, even if you have already gifted away your full exemption amount of $12.92 million in 2023, you have up an additional $690,000 to give away in 2024 (or an additional $1.38 million for married couples).
What to know moving forward?
There’s one big caveat to be aware of: the $12.92 million exception is temporary and only applies to tax years up to 2025. The increased federal gift and estate tax exemption amounts are set to expire on December 31, 2025, under the 2017 Tax Cuts and Jobs Act. Unless there are legislative changes, the exemptions will revert to $5 million per person, adjusted for inflation, starting January 1, 2026. Estimates put the 2026 lifetime limit at around $6.8 million. Depending on the 2024 election outcomes, there could be additional changes to the federal lifetime gift and tax exemption amounts.
Fortunately, though, IRS regulations will allow the use of either the lifetime gift tax exclusion that applies when gifts are made or the exclusion amount applicable when the donor dies, whichever is greater. As a result, people who make large gifts before 2026 don’t have to worry about losing the benefits of the higher gift tax exclusion amount after it’s lowered. In the meantime, it is wise to consider gifting now while the exemption amounts are higher, and gifting earlier in the year.
Article Prepared By:
Evan Peoples | Supervising Senior Tax Accountant
