Introduction
If you’re planning to give a generous gift to friends or family members, it’s important to be aware of the federal gift tax. Gift tax is a tax on the transfer of property from one person to another where the recipient is not paying the full market value for the property.
In this article, we’ll demystify gift tax and explore its limits, exemptions, and strategies to help you stay within the boundaries of the law while making the most of your generosity.
Understanding the Annual Gift Tax Exclusion
The annual gift tax exclusion refers to the maximum amount a taxpayer can gift to another person without incurring gift tax. The exclusion is not a deduction from your taxable income but instead a threshold for gifts that are exempted from gift tax.
The history and evolution of the exclusion limits have seen a steady increase over time. In 2021, the annual exclusion limit was $15,000. This means that you can give up to $15,000 per year to any number of people without incurring gift taxes. Any amount exceeding this limit will be subject to the gift tax.
Who and what qualifies for the annual exclusion? Anyone can gift money to another person and use the annual exclusion without incurring gift tax as long as the gift is of present interest. This means the gift is immediately accessible to the recipient. However, gifts to spouses who are US citizens are unlimited and not subject to gift tax.
If you have gifts that exceed the annual exclusion limit, you’ll need to report them on your gift tax return using Form 709. Filing a return does not mean payment of the tax but is simply a reporting requirement.
Gifting Strategies
The annual gift tax exclusion comes with a set of rules and restrictions, but that doesn’t mean gifting strategies can’t be used to make the most of the exclusion. With the right approach to gifting, you can maximize the annual exclusion and minimize the effect of gift tax.
One gifting strategy involves combining the annual exclusion limit with the lifetime exemption limit set by the IRS. As of 2021, the lifetime exemption limit is $11.7 million. If your gift exceeds the annual exclusion limit, it will be tallied toward your lifetime gifting exemption. The unused portion of the exemption will pass on to your heirs tax-free.
Other strategies include using a trust to gift or taking advantage of portability rules that allow non-gifting spouses to claim the unused portion of the deceased spouse’s lifetime exemption limit. When using gifting strategies, it’s essential to avoid common pitfalls that could trigger gift tax, such as gifting to a trust that fails to meet specific IRS stipulations.
Tax Implications of Exceeding the Annual Gift Tax Exclusion
What if you exceed the annual exclusion limit? While exceeding the limit doesn’t mean you’ll automatically face gift tax, it does mean that you’ll need to report the excess amount on Form 709.
Federal gift tax rates begin at 18% for gifts exceeding the annual exclusion limit and increase to 40% for significant gifts that exhaust your lifetime exemption limit. Calculating federal gift taxes can be a complex process, but many tools and calculators are available to assist with the task.
Fortunately, you’ll find a variety of ways to minimize the effect of federal gift taxes, such as using tax-efficient investments or gifting strategies like using the lifetime exemption or splitting gifts with your spouse. If you fail to include all the gifts exceeding the annual exclusion on your tax return, you may face serious legal and financial consequences, including revocation of your charitable status, fines, or criminal investigation.
Recent Changes in the Gift Tax Legislation
The Tax Cuts and Jobs Act, passed in 2017, increased the lifetime exemption limit for federal estate, gift, and generation-skipping transfer taxes from $5.49 million to $11.18 million in 2018. With inflation adjustments, the exemption limit for 2021 increased to $11.7 million.
The good news is that this increase in the lifetime exemption limit means many taxpayers won’t need to worry about federal estate or gift taxes. However, the changes have some implications. Some taxpayers may reallocate wealth, invest in tax-exempt assets, or use charitable gifting to leverage their exemption and reduce taxes.
Exceptions to the Annual Gift Tax Exclusion
In addition to the annual gift tax exclusion, several exemptions apply to reduce the amount of gifts subject to tax. For example, gifts paid on behalf of another person to qualifying educational or medical institutions are not subject to gift taxes.
Also, gifts to qualified charitable organizations are excluded from gift tax. If you’re gifting to your spouse, you can give an unlimited amount of gifts without gift tax repercussions.
It’s essential to understand how to report exempted gifts on your tax return, such as using Form 709 to report qualifying medical or educational expenses.
Gifting in Estate Planning
Estate planning refers to the management of your wealth and assets to ensure they’re efficiently distributed to your heirs or loved ones after your passing. Gifting can be a key part of estate planning, and there are numerous benefits to establishing a gift-giving program.
The right gift-giving strategy can help reduce your estate tax while maximizing your lifetime gift exemption limit. You can also use trusts as part of your estate planning strategy to leverage tax-efficient gifts or establish ongoing income for beneficiaries.
Gift Taxes and Gifting during the Pandemic
The pandemic has brought about unprecedented changes in the US tax system, including those related to gift taxes and gifting strategies. Increased job loss and changes in income make the pandemic an excellent time for clients to implement gifting strategies and take advantage of low valuations.
The pandemic has also brought about changes in estate planning, such as enabling clients to meet with estate planning attorneys remotely and explore various estate planning tools, including trusts and lifetime giving strategies.
Conclusion
Gift tax laws are complex, but they don’t have to be intimidating. Armed with the right information, you can make smart gifting decisions that maximize your annual exclusion limit and reduce your tax liabilities. By using gifting strategies, avoiding common pitfalls, and staying up to date on tax laws, you can stay on top of your tax obligations and make your generosity work for you.
