What are Gift Taxes?
You may have realized that estate planning and distribution can get expensive, fast. For many, the simplest solution to avoid paying estate taxes is to instead give away their estate during their lifetime so that there isn’t anything left to tax. But not so fast. Gift taxes are federally imposed taxes that put limits on how much you can give away annually during your lifetime tax-free. As you begin estate planning, it’s important to understand what gift taxes are, why they exist, and who pays them.
What is Considered A Gift?
A gift in the eyes of the federal government is seen as the transfer of property or funds from one individual to another without any payment or presumption of payment attached.
What Are Gift Taxes?
Gift taxes are a 40% tax on gifts imposed by the federal government on gifts that exceed the annual tax exempt threshold.
Gift taxes were put in place to keep wealthy families from evading estate taxes by transferring assets tax-free.
Who Needs to Pay Gift Taxes?
Gift taxes are paid by individuals who give above the annual exclusion. In 2022, individuals are able to give up to $16,000 tax-free. For married couples, this number doubles to $32,000. These numbers are $15,000 and $30,000 respectively for the 2021 tax year.
This means that whether you’re sending money off to grandchildren, nieces, nephews, or helping out a friend, you personally can give up to $16,000 without owing anything in taxes.
Let’s say, for example, you decide to help a grandchild out with college and write them a check for $7,000. Because that $7,000 is below the annual exclusion of $16,000, that gift cannot be taxed.
Now let’s change the situation slightly. Instead of giving $7,000 to your grandchild, you give $25,000. Under the annual exclusion, the first $16,000 is “free”, or untaxed. However, the additional $9,000 will count as a taxable gift.
If your gift exceeds the annual exclusion you’ll also be asked to fill out form 709.
Keep in mind that while taxed, this gift tax is not paid outright. Instead, it accrues and is deducted from the lifetime exemption amount. It’s also important to note that annual exclusions only apply to present interest gifts.
For example, if you give $5,000 to a family member directly to use today, that amount is included within the annual exclusion and therefore non-taxable.
However, if that amount were to be instead added to a trust, or a “future” interest, that gift becomes exempt for the annual exclusion and is therefore taxable.
The IRS allows a maximum of 12.06 million to be sheltered before federal taxes kick in (2022). For 2021 this number is 11.7 million. If you give a gift above the annual exclusion, the taxable portion is applied to this amount. This threshold is the same for estate taxes. Essentially, gift taxes help to ensure that property and assets get taxed, both during your lifetime and after.
Estates that are below the 12.06 million dollar threshold are exempt from estate taxes, When states are valued above this number, they become taxable.
So, what happens if someone passes away with an estate less than 12.06 million?
Portability election allows the executor of a will to receive the remainder of a spouse’s exclusion amount to add to their own estate.
Let’s say that a married man passes away with an estate valued at 8 million. As the executor of his estate, his wife may file an estate tax return so she can make portability elections so that unused exclusion amount can be added to her’s.
To learn more about estate taxes, check out our blog What are “Death Taxes”?