The gift tax is the federal tax on gifts that is paid by the individual who is making the gift, called the donor. The tax will apply whether or not the donor intends the transfer to be a gift to that individual or not.
The gift tax amount may vary yearly, so an individual must check the current amount. For the years 2018-2021, the annual exclusion was $15,000.
For the year 2022, the annual exclusion is $16,000. This means that a single donor may give up to $16,000 in one year in assets or cash to an unlimited number of individuals without incurring gift tax liability.
Married couples may give $32,000 in one year in assets or cash to an unlimited number of individuals without incurring gift tax liability. The federal gift tax is intended to prevent individuals from paying the federal estate tax by giving away all of their money before death.
When Does a Gift Become Taxable?
A gift for more than $16,000 by one donor in one year is considered a taxable gift and may cause the donor to have to pay a gift tax. The gift tax, however, is not due until an individual has given away over $1.5 million in their lifetime.
This $1.5 million exemption means that most individuals will never have to worry about paying the gift tax.
What Qualifies as a Gift?
A gift eligible for the $16,000 annual exclusion currently only applies to gifts of income and property that the recipient can use presently.
What is the Tax Treatment of Gifts Made within Three Years of Death?
When an individual passes away, estate taxes may apply to the transfer of their property at their death. Estate taxes are taxes on the transfer of an estate from the decedent, or deceased individual, to their beneficiaries or individuals who inherit from the decedent.
Estate taxes are imposed upon the estate itself and not upon the beneficiaries of the estate. The total taxes that are owed are calculated by adding the fair market value of all of the assets of the decedent, including real and personal property and the date of their death.
Before their death, an individual may be able to reduce the amount of estate tax levied by making gifts to other individuals. This reduces the total value of their estate and, thereby, the amount of taxes that will be owed.
If an estate tax applies to an individual’s estate at their death, it will apply to an estate where the value has been reduced by the number of gifts provided to other individuals. Smaller estates are subject to lower taxes than those levied on larger estates.
Tax laws do not allow an individual to gift their entire estate if the gifts are made too close to their date of death. This prohibition on gifting an entire estate is intended to prevent individuals from attempting to avoid paying estate taxes.
How Does Tax Law Treat Gifts Made Within Three Years of Death?
Pursuant to federal laws, if an individual makes a gift of property within 3 years of the date of their passing, the value of that gift will be included in the value of their gross estate. An individual’s gross estate is the dollar value of their estate at the time of death.
Gifts made during an individual’s lifetime are called inter-vivos gifts, or gifts between living individuals. Gifts, similar to estates, are subject to tax.
Individuals who make gifts must pay the gift tax, not those who receive the gifts. The gift tax an individual will pay while they are still alive is also included in the value of their estate.
When an individual gives a gift, the first $16,000 value of the gift is not taxed. In other words, the first $16,000 of a gift is excluded from taxation.
As noted above, this exclusion is called the gift tax exclusion. The amount of the exclusion may vary by year, as discussed above.
If the gift exceeds $16,000 in value, then the value of the gift that exceeds $16,000 is subject to the gift tax. The percentage of the gift tax can range from 18% to 40% of the value of the gift, which exceeds $16,000.
The amount of this gift tax that is paid would be included in the value of the decedent’s estate if the gift which was taxed was made within 3 years of the date of the decedent’s death. The gift itself will only be included in the total estate value to the extent that it exceeds $16,000.
In other words, if the decedent made a gift within 3 years of their death worth $26,000, only $10,000 of that gift, the amount above the sum excluded from tax, will be included in their gross estate. The decedent’s gross estate will also increase by the amount of the gift tax which was paid on that gift.
How Can I Avoid Paying the Gift Tax?
There are several ways an individual may avoid paying gift tax, including:
- Donating a gift to a charity;
- Limiting any interest gifts to $16,000 or less in 2022;
- Giving a gift or leaving their money to a spouse;
- By paying someone’s medical or school expenses; and
- Arranging for the person receiving the gift, known as the donee, to be responsible for paying the gift tax.
What about Spousal Deductions?
A gift of any amount between spouses is 100% deductible for gift tax purposes. This is referred to as the unlimited gift tax marital deduction.
This gift exclusion only applies to spouses who are United States citizens.
Do Medical and School Expenses Qualify as Deductions?
Tuition expenses and medical bills are excluded 100% for gift tax purposes. These exclusions are permitted independent of the giver’s relationship with the recipient.
However, it is important to note that the payment cannot be made directly to the recipient. It must be made to the educational institution or the medical care facility.
Do I Need a Gift Tax Lawyer?
Tax laws by themselves are often complex and may be frustrating for most individuals. Gift tax laws may be even more so.
If you have any issues, questions, or concerns related to gift taxes, it may be helpful to consult with a tax lawyer in your area. Your tax lawyer can assist you with the understanding that gift tax laws will affect you.
In addition, your lawyer can provide you with legal options for avoiding the gift tax and help you plan your gifts. It is always best to seek legal advice before making a gift so you can plan to avoid the gift tax as much as possible.
If you have assets and are concerned about gift and estate taxes, your lawyer can assist you with setting up a living trust or using other methods to avoid the estate tax. If you face an audit due to unpaid taxes, your lawyer can help you get through the process.
Lastly, if there are any changes to the law, your attorney can provide you with updates regarding your legal rights and options.