Do I Have to Pay Taxes on a Gift?
If you are aware of the federal gift tax, you may have wondered if you needed to pay taxes on money, property, or a valuable item given to you as a gift by a family member or friend. Fortunately, the federal gift tax exclusion is high enough that most run-of-the-mill gifts are not subject to the tax. Only when the value of the gift is more than $17,000 (for 2023) will the Internal Revenue Service begin to take an interest, and some gifts are excluded from the tax.
Even if you have received a gift that's valuable enough to be subject to the gift tax, you won't be the one paying the IRS. That's because the gift tax liability is actually assessed on the person giving the gift. However, the IRS will allow the person receiving the gift to pay the tax bill on behalf of the person giving it.
While the gift tax is often lumped in with the federal estate tax, the estate tax is a separate inheritance tax. If you make a gift through your will, it may be subject to the estate tax because it is the estate that distributes your assets after you die. Your taxable estate may be subject to the estate tax if the total value of all of your assets is above the estate tax exemption.
What Gifts are Taxed?
According to the IRS, you have received a gift if you have been given something of value and give something of less value — or no value — in return. The IRS sets an annual limit on the value of the gifts taxpayers can give to another individual — sometimes referred to as the donee — without it being taxed. This is known as the annual gift tax exclusion. For 2023, the annual exclusion is $17,000.
There is also a lifetime limit on the gifts you can give one person without it being subject to tax. The lifetime exclusion is indexed for inflation and was $12.92 million in 2023.
You may have noticed that it is impossible to reach the lifetime gift exclusion amount by giving someone less than $17,000 during a calendar year, even if the gifts are given annually for 100 years. That's because it only comes into play with large gifts.
For example, if you give your niece a gift of $13 million in one year, you can't then apply the exclusion to a $5,000 gift you give her the next year. Every gift you give her after the $13 million will be subject to the gift tax, no matter how small the gift is.
Who Reports the Gift?
The person giving the gift is responsible for reporting it to the IRS and paying any tax due. The reporting is done by filling out and filing IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. You must attach your gift tax return to the annual income tax return you file by April 15 each year.
If you have received a gift, be sure to leave it out of your taxable income when you file your annual federal income tax return.
How is the Gift Tax Calculated?
The gift tax is calculated as a percentage of a taxable gift's value. The gift tax rate can run from 18% to 40%, depending on the gift's value. If you are giving something other than cash, such as stocks, art, or real estate, you must use the fair market value of the gift at the time it was given.
The gift tax rate starts out at 18% for taxable amounts under $10,000 and increases to 40% for amounts over $1 million. The rates are adjusted each year for inflation and may be found in the instructions for Form 709.
Gift Tax Exemptions
Not all gifts are subject to the gift tax. For example, you can give an unlimited amount to your spouse without paying the tax if they are a U.S. citizen. If your spouse is not a U.S. citizen, the amount is limited to $175,000 (for 2023).
Additionally, you will not need to pay the gift tax on gifts made for the following reasons:
- To pay expenses for an educational institution
- To pay medical expenses
- Gifts to political organizations
Since the above-listed gifts are exempt for gift tax purposes, they will not count toward your annual or lifetime gift tax exemption amount. For example, if you give $35,000 to your grandchild for their college tuition, you can still give them an additional $10,000 tax-free because the tuition gift is not included in the exclusion calculation.
Capital Gains Tax May Apply
The capital gains tax applies to the profit you earn from selling an asset, such as stock, property, or a small business. If you have received a gift worth far more than the giver paid for it, you may need to pay the capital gains tax when you sell it. That is because the IRS will determine the price at which the giver purchased the asset when calculating the profit you earned by selling it after the transfer of property.
For example, if your aunt gifted you a rental property for which she paid $50,000 and you later sold it for $250,000, you would have a taxable capital gain of $200,000.
Avoiding the Gift Tax
If you are planning on gifting someone money, property, or assets in excess of the exclusion amount, there are several strategies that may be employed to avoid the tax. The two most popular are:
Gift splitting: Married couples are each allowed to give a gift of up to the annual exclusion amount to the same individual without paying the gift tax. That means each spouse can give one of their children up to $17,000 each tax year ($34,000 combined) tax-free.
Gifts to trusts: The gift tax exclusion generally does not apply to gifts made to certain types of trusts that are set up to receive and distribute the funds to one or more beneficiaries. Thus, instead of giving the funds directly to an individual, it is given to the trust, and that individual is named as a trust beneficiary who can withdraw the assets.
State Gift Taxes
The only state that assesses a gift tax is Connecticut. However, some state inheritance tax rules may apply to gifts made shortly before you die. For example, New York has a three-year clawback rule that will treat any gifts given in the three years before you die as part of your estate.
Additional Questions? Contact an Attorney
If you are giving one or more people gifts and are concerned they may be large enough to subject you to the gift tax, you may want to contact a tax attorney first. An attorney who is an experienced tax professional can tell you if a gift will be taxed and help you develop strategies to avoid paying the tax if it is.
Unlike a CPA, a tax attorney will have the tax law expertise needed to defend clients before the IRS. A lawyer may also help with estate planning so that your gifts are given after you die, when they won't be subject to the gift tax.
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