Gift Tax and Estate Tax: An Overview
Gift taxes and estate taxes could be imposed on the transfer of property from one person to another. But both can be minimized or avoided altogether, with thoughtful estate planning. This article provides an overview of both forms of transfer.
Personal Gifting and the Federal Gift Tax
People choose to gift for a variety of reasons, such as:
- A family member or loved one is in need and the donor wants to help
- The donor wants to make a difference in someone's life or in the world
- It would be financially beneficial for the donor to reduce the size of their estate during their lifetime (Both to avoid taxes now and estate taxes later)
Gifting to an individual is not the same as a charitable donation to a tax-exempt nonprofit or private foundation. You cannot deduct a personal gift from the adjusted gross income on your tax return, as you can a gift to charity. Gifting will not reduce your taxes this year. In fact, it could increase your taxes if your gift triggers a federal gift tax. (Or in Connecticut, a state gift tax.)
If you are considering personal gifting, it's important to understand the IRS gift tax exemption and exclusion rules. A federal gift tax can apply to gifts of money or things with monetary value (securities, artwork, vehicles, etc.) if something of equal or greater value is not received in return.
Gifting more than is allowed by law, or for unapproved purposes, can trigger a gift tax at some point. The tax is paid by the donor, except by special arrangements. The recipient does not pay income tax on the gift received.
Gift Tax Exemptions
There are three main exemptions for gift taxes:
- Gifts to spouses: Gifts between spouses are 100% exempt from gift tax if the spouse is a U.S. citizen.
- Gifts to charity: A gift to a qualified tax-exempt charity is not considered a gift, it is a charitable contribution. It is not only exempt from the gift tax, but it is also deductible up to 100% on the donor's adjusted gross income on their tax return.
- Gifts to political organizations: To learn more about how the gift tax exemption applies to political contributions see the Internal Revenue Service Code 527.
Gift Tax Exclusions: Gifts to individuals
Each year a donor can gift any individual money or property up to a certain dollar value. That value is set by the IRS. In 2022, the annual exclusion amount is $16,000 for each person you give to.
If a married couple gives a gift to an individual, they can together give $32,000. The gift exclusion amount changes every few years so be sure to check with your tax advisor, tax attorney, or the IRS for up-to-date tax law information.
Who Can Receive Individual Gifts?
That gift can be given to anyone you choose. It could be a family member, a friend, or someone in need. And you can give to as many people as you choose. Each person can receive a gift up to the amount of the gift tax exclusion.
Or course, you can choose to give more than that amount. If you do, you as the donor may or may not have to pay a gift tax on the amount of your annual gift above the annual gift tax exclusion limit. (More on this later.) The tax rate for that portion of your gift would be between 18% and 40%. See IRS Gift Tax Return Form 709 to learn more.
A donor can also pay school tuition or medical expenses on someone's behalf, without triggering a gift tax. Payments must be made directly to the school (any grade level or college), or the medical provider, pharmacy, or medical insurer. Again, this gift can be given to anyone you choose. And there is no dollar limit on these payments.
Lifetime Gifting Limits
Every American taxpayer has a lifetime gift exclusion amount. This is much larger than the annual gift tax exclusion. For many years it increased incrementally, but with the 2018 tax reform law, the lifetime gift exclusion amount nearly doubled. In 2022, the exemption amounted to $12.06 million, per donor. Unless Congress changes the law, the exemption will drop to $6.2 million at the end of 2025.
You can give up to the annual exemption amount each year without it impacting your lifetime gifting limit. If you exceed the annual amount in any year, that will be deducted from your lifetime gift tax exemption and your federal estate tax exemption.
Examples of Individual Gifting
Elizabeth becomes seriously ill and cannot work for a period of time. Her parents can provide $32,000 toward her daily living expenses without concern about a gift tax. They can also pay her health insurance premiums and medical deductibles, with no dollar limit. The donee, their daughter, has no tax liability for this money.
College is important to Jason's grandfather. He started putting money into a 529 account soon after Jason was born. Now he'd like to ensure Jason can devote himself to his studies and not have to work while he is in school. He can give an outright gift of $16,000 to Jason, which he can use to pay for his dorm and food. Funds from the qualified 529 education account can pay for tuition and books. Grandpa can also pay any uncovered education expenses directly to the college.
Gift Tax Surprises
Generous family and friends could find themselves with a surprise bill from the IRS for a gift tax they did not expect. Some examples of this could be:
- A friend buys a new car and gives you their used car, which has a fair market value of $20,000. That $4,000 over the gift tax exclusion limit could be tax liability to the donor.
- Grandma picks up the tab for a wedding of a grandchild. That's a potentially taxable gift.
- You loaned your brother $25,000 to pay off his credit card debt and he never paid you back. Later on, you told him he didn't need to repay you. You're just glad he's back on his feet again. But now that loan has become a gift and it's $9,000 over the gift exclusion limit.
- You loaned your friend $2,000 for their first month's rent, with 0% interest. A loan without interest is considered to be a gift by the IRS, but it's below the exclusion amount so you won't see a tax bill.
- Your sister moved into mom's house to take care of her now that she can't manage on her own. It made sense to put sis's name on mom's bank account because she'll need to pay the bills, but if sis can use mom's money at any time, the IRS will see it as a gift.
Eleven states and the federal government require the estate of a deceased person to pay estate taxes (some call it death taxes). The state in which the decedent lived may impose a state estate tax, and states where real estate or personal property is located may also impose an estate tax.
Estates are required to file a federal estate tax return if the valuation of the "gross estate," minus exemptions and deductions, exceeds a certain dollar amount ($12.06 million in 2022). How does the IRS determine the value of the gross estate? It adds the value (or share of value) of all property in which the decedent had an interest at the time of death and subtracts estate exemptions and deductions. This is the taxable estate value.
Estate Tax Exemptions
Personal exemption: At any time, Congress may increase or decrease this amount, or even repeal the estate tax altogether. The "personal estate tax exemption" in 2022, the personal exemption amount was $12.06 million.
Marital deduction: A deceased person's estate can pass tax-free to a surviving spouse, as long as the surviving spouse is a U.S. citizen and the deceased spouse's interest in the estate passes directly to the spouse upon the decedent's death).
Other deductions: Other deductions against the gross estate include probate expenses, funeral expenses, debts owed by the estate, taxes owed by the estate, and charitable bequests.
Filing the Estate Tax Return
The executor, personal representative, or person in possession of the estate's assets must file the estate tax return within nine months of the decedent's date of death. The estate can apply for a six-month extension to file, but the taxes must be paid within nine months of the decedent's death. The time for payment of the estate tax may be extended in certain circumstances.
How Lifetime Gifting Impacts Estate Taxes
The value of lifetime gifting is that it can reduce the size of the taxable estate so that it never exceeds the amount that would trigger federal (or state) estate taxes. Of course, there are other strategies one can use to minimize estate taxes, but annual gifting is a popular choice.
Let's look at an example of how lifetime gifting, the marital deduction, and personal estate tax exemption might work together in practice.
During Bob's lifetime, he gifted the maximum annual amount of money to his only child, Kate. He also paid for a college education for his daughter, niece, and nephews. Over the course of his life, his gifts to these and other family members added up to $1 million.
Bob's estate is worth $22 million. His will states that $10 million go to his wife, and $12 million to his daughter Kate. No part of the $10 million Bob leaves to his wife will be subject to estate tax, as Bob's wife is a U.S. citizen and has a spousal exemption. Kate's inheritance will also be free of estate tax because it is less than the $12.06 million estate tax exemption. Bob had previously given away $1 million that would have put his estate over the limit.
Questions About Gift Taxes and Estate Taxes? Talk to an Attorney
An experienced tax attorney or estate planning attorney can answer your questions about strategies you can use to reduce your liability for taxes due after death.
Can I Solve This on My Own or Do I Need an Attorney?
- DIY is possible in some simple cases
- Complex estate planning situations usually require a lawyer
- A lawyer can reduce the chances of a family dispute
- You can always have an attorney review your forms
Get tailored advice and ask your legal questions. Many attorneys offer free consultations.