One of the most common areas of concern in financial planning centers on gifts and their potential taxability. If you’re generous with family and friends, it’s crucial to understand whether their gifts will incur some sort of tax liability before you sign the check.
Fortunately, few people give away enough money each year or over their lifetimes to incur a gift tax. As of 2022, you can give away up to $16,000 per year per person ($12.06 million over your lifetime) without having to worry about it.
However, if you give away anything close to that amount, you need to understand the basic rules to determine when it applies to your circumstances before declaring yourself out of the woods.
What Is the Gift Tax?
A gift is a transfer of property for less than its true value or for no value at all. The person giving the gift is considered the “transferor” or “donor.” The person receiving the gift is typically called the “transferee” or “donee.” A gift can be money or property so long as you give it for less than you receive in return.
The gift tax is a tax the IRS levies on gifts over the lifetime exemption. Typically, the person giving the gift pays the tax, not the receiver. Fortunately, most gifts only lead to additional paperwork.
How the Gift Tax Works
You can give up to a certain amount per person each year without paying taxes. That amount is the annual exclusion amount, which is $16,000 in 2022 ($15,000 for 2021). If you’re married, you can both give away the annual exclusion amount without worrying about taxes or paperwork.
But you still don’t necessarily have to pay taxes on any amounts over the threshold. There’s also a lifetime exclusion amount, which refers to the total amount you can give away over your lifetime without having to pay taxes. As of 2022, it’s $12.06 million ($11.7 million for 2021).
You have to report the amount in excess of the annual exclusion each year. But you don’t start paying taxes on your gifts until you’ve exceeded your annual exclusion amount by enough to exceed the lifetime exclusion amount.
For example, say you gave a friend $100,000 for their birthday in March 2022. You can exclude the 2022 annual exemption amount of $16,000. But you must report $84,000 in taxable gifts on IRS Form 709. This form serves as a tracking tool for the taxable gifts made for each period over your lifetime.
The good news is you don’t need to pay taxes on that amount. It just subtracts $84,000 from your lifetime exclusion amount. Tax liability doesn’t come into play until you give away your first dollar over the lifetime exclusion amount, which will never happen so long as you never exceed the annual exclusion amount for a single gift to one person in a calendar year.
Continuing the previous example, say you and your spouse together gave the same $100,000 for your friend’s birthday. Here, you’d receive two annual exemptions as a married couple, and you’d only have to report $68,000 as a taxable gift on Form 709. It can pay to be married!
How to Calculate Gift Tax
Once you exceed the lifetime gift tax exemption, you must pay taxes on any amount over that. There are two things to know about the gift tax at this point.
First, the amount may change from year to year. For example, in late 2021, the IRS announced it would increase 2022’s lifetime exemption amount to $12.06 million due to inflation. That could easily happen again.
Moreover, in 2026, the amount will radically decrease. That’s because the Tax Cuts and Jobs Act of 2017 increased those amounts substantially, but the provisions that created the higher exemptions are set to sunset (legal jargon for “automatically terminate”) unless Congress takes action to stop it. They should go down to roughly $6 million at that time (adjusted for inflation).
Second, the gift tax rate you pay depends on how much you go over the lifetime exemption amount.
Gift Tax Rates
If you find yourself in the fortunate position to have given away more than the lifetime exclusion amount in taxable gifts, you’ll be liable for gift tax on any future gifts that exceed the annual exclusion amount for that year.
Once you’ve determined the taxable gift amount on Form 709, you’ll apply a gift tax rate of between 18% and 40%, depending on the amount you’ve given away. The more you’ve given away, the higher your gift tax rate. For instance, you must pay a 40% rate on taxable gifts over $1 million in any one year.
This table shows the rates you must pay based on the amount of excess taxable gifts per year.
|Taxable Gift (Min.)||Taxable Gift (Max.)||Tax Rate||Maximum Gift Tax|
|$1,000,000+||No Limit||40%||No Limit|
Imagine that, through outstanding fortune and perseverance, as of 2022, you’ve managed to give away more than $12.06 million throughout your lifetime. Amazing work! However, the next gifts you give in excess of the $16,000 annual exclusion will force a gift tax charge.
Say you gave $25,000 to five cousins during the year. Each gift includes an exempt portion ($16,000) and a taxable portion ($9,000). First, you must calculate the total amount of taxable gifts for the year by subtracting the total amount of your exemptions from the total amount of your gifts.
($25,000 x 5 cousins) – ($16,000 x 5 exemptions) = $125,000 – $80,000 = $45,000 (total taxable gifts)
Looking at the chart, a total taxable gift amount of $45,000 results in a 24% tax rate. So you multiply 24% times $45,000 to arrive at your gift tax amount.
$45,000 x 24% = $10,800 (total gift tax due)
What Counts as a Gift?
Generally speaking, a gift is a transfer of value for little or no consideration in return. Most commonly, that means a willful transfer of money between two parties. People also frequently give many different types of property, like securities or tangible goods such as vehicles, as gifts.
Interestingly, it may be easier to think about what isn’t a gift. Among these exceptions: amounts transferred below the annual exclusion amount, transfers between spouses, and transfers for tuition or medical expenses. Contributions to political organizations aren’t gifts in this context, either.
Donations to charitable organizations are deductible as itemized deductions on your income tax return. The IRS doesn’t consider them gifts for gift tax purposes. Gifts to friends and family members other than your spouse are not income tax-deductible, but they may count as taxable gifts, depending on how much you give away.
How to Avoid the Gift Tax
There are ways to avoid gift tax legally. They’re usually best employed with planning and deliberation, so it’s crucial to know the boundaries or work with a qualified tax professional.
Leveraging the Annual Gift Tax Exclusion
As of 2022, you can give away up to $16,000 per person per year to non-spouse individuals. Gifts to spouses are unlimited. That means all gifts to spouses are tax-exempt and aren’t gifts for tax purposes.
That plays out in some interesting ways. You could give $15,000 to 10 different people and $100,000 to your spouse without ever having to declare that you gave money away. On the flip side, you could give $17,000 to your best friend the following year and you’d have to file a gift tax return.
As such, spreading gifts out over a period of years, otherwise known as “structuring” gifts, is an effective way to work around gift tax reporting requirements. While this is simple if you’re looking to give away cash or securities, it’s not easy to do if gifts have to occur at once or if you’re dealing with property you can’t easily divide, like real estate.
Another way to avoid gift tax is by giving money directly to a medical provider for services rendered or an educational institution for tuition payments. These gifts are exempt from gift tax rules and can be unlimited in nature without any paperwork requirement.
With all other gifts, the key to avoiding gift tax in any given year is to ensure you keep gift amounts under the current annual exclusion amount. You’ll save time and paperwork and avoid the gift tax entirely.
Leveraging the Lifetime Gift Tax Exclusion
The lifetime gift tax exclusion refers to the cumulative amount of taxable giving you can do before the IRS levies a gift tax. As of 2022, this amount is $12.06 million. You’d need to give away cumulative taxable gifts in excess of that amount before facing a tax liability.
Following the above example, if you keep annual gifts below $16,000 to all recipients, you’ll never have anything to count against your lifetime gift tax exclusion. If possible, it’s a suitable route for most everyday taxpayers.
If you consistently make gifts that exceed the annual exclusion amount, the excess counts against your lifetime tax exemption. Once you exhaust your exemption, additional taxable gifts result in gift tax. Luckily, that never becomes an issue for the vast majority of taxpayers.
Giving to Your U.S.-Citizen Spouse
You can give an unlimited amount to your spouse, assuming they’re a U.S. citizen, even if they don’t reside in the U.S. If your spouse isn’t a U.S. citizen, the annual exclusion for gifts is $164,000 in 2022.
To utilize gift-splitting — the strategy that allows married couples to benefit from two annual gift exemptions — both spouses must be U.S. citizens or residents. Gift splitting is unavailable to non-U.S.-citizens who are also non-residents.
Generally speaking, citizenship will afford the most privilege between spouses, while residency will afford some level of exemption but with limits.
Gift Tax FAQs
If you’ve given or received a gift of any amount, it’s entirely possible some of these questions have crossed your mind.
Who Pays the Gift Tax?
The giver, not the receiver, usually pays the gift tax. Fairly often, people who have received large gifts want to know if they owe any tax. Fortunately, the answer is no unless they’ve agreed in advance to assume the giver’s tax liability, which is very uncommon.
But there usually isn’t any gift tax due at all unless you exceed the lifetime gift exemption.
How Much Can I Give to Someone Tax-Free?
As of 2022, you can give up to $16,000 per individual per year without having to report the gift on your tax return. In other words, gifts of $16,000 or less fall under the annual exclusion amount, which means they’re tax-free.
How Much Can I Give to a Family Member?
When it comes to non-spouse family members, the standard gift tax rules apply. As of 2022, you can give up to $16,000 to a non-spouse family member without having the amount count against your lifetime exemption.
What’s the Difference Between the Gift Tax and Estate Tax?
Gift tax is concerned with the distribution of assets during your lifetime. In short, if you give more than the current annual exclusion in any one year, the excess will count against your lifetime gift exemption. If your cumulative lifetime taxable gifts exceed your lifetime gift exemption, you pay gift taxes.
The IRS levies estate tax on the total value of your assets (less certain deductions) after your death. In a similar fashion to the gift tax calculation, you only pay estate taxes if the total value of your estate is greater than the federal estate tax exemption (which is also $12.06 million for 2022).
Unless you’ve given away millions during your lifetime, you don’t have to pay any gift tax at all.
But if you find yourself in a situation that might prompt a gift tax, speak with either a qualified tax professional or a certified financial planner who can help you plan your giving in a tax-smart way.