The federal government imposes a gift tax of up to 40% on transfers of property from one person to another, whether it’s cash or a physical item. If your gift exceeds a certain value, you may have to file a gift tax return and pay the gift tax.
What Is the Gift Tax?
The gift tax is a tax that individuals must pay when they transfer a gift to another individual. The IRS defines a gift as a transfer of property from one individual to another, where the giver doesn’t receive compensation of equal value. The gift could be money, but it could also be other assets, such as stock or real estate. The gift tax was initially enacted in 1924, temporarily repealed in 1926, and reenacted again in 1932. It was designed as a way to prevent wealthy families from avoiding estate taxes by transferring wealth to their children during their lifetime.
Who Pays the Gift Tax?
Generally, you don’t have to worry about paying any taxes on gifts you receive from loved ones. It’s the giver of a gift, not the receiver, who would file a gift tax return and potentially pay the gift tax. In most cases, it’s pretty clear when a gift is being made—anytime you transfer something of value from one person to another without receiving any money in return, generally speaking. But there are some situations where someone might be transferring a gift without truly thinking of it as a gift. For example, if you are giving a gift to your child, that is a taxable exchange. The only individual you can give a gift to without potential tax consequences is your spouse. Something could also be considered a gift even if there is a partial payment made by the receiver. Suppose that a couple decided to sell their home to their adult child for a price of $250,000, but the fair market value of the home is actually $500,000. Even though their child paid them, the $250,000 difference between the purchase price and the market value is considered a gift. The good news is that there are plenty of gifts that won’t be subject to the gift tax. These include:
Tuition or medical expenses paid on someone else’s behalfGifts to your spouseGifts to a political or charitable organization
Annual Exclusions and Lifetime Limits
Due to annual and lifetime exclusions, most individuals will never actually end up paying the gift tax, and many won’t have to file gift tax returns for the properties they transfer to others.
The Annual Exclusion
For tax year 2022, the annual exclusion is $16,000. For tax year 2023, it’s $17,000. Individuals won’t have to file a gift tax return until they gift at least that much to another individual in one tax year. For example, if you gift someone $20,000 in 2022, you will have to file a gift tax return for $4,000, which is the amount over the annual exclusion. Keep in mind that the annual exclusion applies per individual, which means you can gift significantly more than that per year, as long as it’s given to multiple people or organizations. It also means that a married couple can give another individual double that annual amount before they must file a gift tax return since each spouse can technically gift up to the annual exclusion amount.
The Lifetime Exemption
Filing a gift tax return doesn’t mean you’ll actually end up paying gift taxes, as the IRS also has a lifetime exemption for the total amount someone may gift throughout their lifetime before they pay gift taxes. The lifetime exemption is $12.06 million for the 2022 tax year and $12.92 million for tax year 2023. For example, if you gifted someone $20,000, you’d have to file a gift tax return for $5,000, the amount over the annual exclusion. However, that $5,000 would then also count toward your lifetime exclusion, so if you haven’t used it up yet, you may not have to pay taxes on that money at that point. Large gifts transferred during your lifetime may also have tax implications after your death. Estates that exceed a certain amount are subject to the estate tax before they can be transferred to beneficiaries. But the gift tax exclusion and estate tax exclusion are interconnected. The lifetime exemption applies to both your gift and estate taxes. Any gifts you transfer during your lifetime that count against your lifetime exemption also reduce the threshold for when your estate may be subject to estate taxes. Let’s look at another example. Suppose that over your lifetime, you gift $3 million in excess of your annual exclusions. That money counts against your lifetime exemption of $12.06 million. By the time you pass away in 2022, you have $9.06 million left of your lifetime exclusion. Any of your estate’s value that exceeds $9.06 million would be subject to estate taxes.
How Much Is the Gift Tax for 2022?
If you eventually exhaust your lifetime exclusion and must pay gift taxes, the rate you’ll pay depends on the value of gifts subject to taxes. The gift tax rate ranges from 18% (for the first $10,000 in taxable transfers) up to 40% on taxable transfers over $1 million. Here’s a table that illustrates the rate you’ll pay for certain gift amounts: Suppose that Janet gives $21,000 to each of her four adult children every year. She’s already used up her lifetime exclusion, so everything above and beyond her annual exclusion is taxed. The taxable portion of her gifts is $5,000 per recipient, or $20,000 total. The first $10,000 she gifts her kids is taxed at a rate of 18%, for a total tax of $1,800. The next $5,000 is taxed at the next gift tax rate of 20%, amounting to $1,000. The total gift tax that Janet must pay for the year is $2,800. You can think of the gift tax the same way you would income taxes, where each chunk of money is taxed at the rate for the bracket it falls into. The first $10,000 in taxable gifts is taxed at 18%, the next $10,000 is taxed at 20%, the next $20,000 is taxed at 22%, and so on.
