Business Tax

Tax Rules for Gifting: Benefits, Exclusions & Tips

Hood & Associates CPAs, PC

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December 21, 2023

When you give a gift to a friend or family member, you’re likely not thinking about taxes, but the Internal Revenue Service (IRS) may want to know about it and even collect taxes.

Don’t worry—you likely don’t have to worry about the gift tax for normal holiday or birthday presents unless your gifts are really, really generous. There are many ways to give assets—including cash, stocks, cars, and real estate—tax-free.

Understanding the gift tax rules can help you properly plan.

What Is the Gift Tax?

The gift tax is a federal tax on transfers of money or property to other people who get nothing (or less than the full value of the transfer) in return. Gift taxes are paid by the giver, not the receiver.

Fortunately, a large portion of your gifts are tax-free due to two thresholds: the annual gift tax exclusion and the lifetime gift and estate tax exemption.

What Is the Annual Gift Tax Exclusion?

The annual gift tax exclusion allows you to give away up to a specific dollar amount to any number of people in a single year without filing a gift tax return or paying the gift tax.

That amount is adjusted annually for inflation. For 2023, it is $17,000, and it rises to $18,000 in 2024. A married couple has a separate annual gift tax exclusion for each spouse.

So, let’s say you are married and have four children. In 2023, you and your spouse could each give $17,000 to each of your four children without filing a gift tax return or paying taxes on the gifts. That’s a total of $136,000 ($17,000 x 2 spouses = $34,000 x 4 children = $136,000) you can give away with no tax consequences to you or your children.

What Is the Lifetime Estate and Gift Tax Exemption?

The federal government limits how much you can give during your life and after death with the lifetime gift tax exclusion. This amount is also adjusted annually. For 2023, it is $12.92 million. Spouses can combine their lifetime exemption to transfer $25.84 million without paying estate taxes. For 2024, the lifetime gift tax exemption rises to $13.61 million, or $27.22 million for a married couple.

How Does the Lifetime Exclusion Amount Work?

Returning to the example above, say you and your spouse want to gift $50,000 to each of your four children in 2023 instead. Each gift exceeds the annual gift tax exclusion amount by $16,000, so you and your spouse must file a gift tax return using Form 709.

However, you don’t necessarily need to pay taxes on those gifts. Instead, those gifts will reduce your available lifetime exclusion. So, for 2023, your combined remaining lifetime exclusion would be $25,776,000 (the $25.84 million combined exemption amount for 2023 less $16,000 multiplied by four children).

If you were to pass away in 2023 after giving those gifts, your estate would pay federal estate tax on the value of your estate that exceeds $12,856,000.

If you didn’t want to let those gifts chip away at your lifetime estate tax exemption, you could choose to pay taxes on those gifts. The highest tax rate for gifts is 40%.

Tax Benefits of Gifting

Beyond simple generosity, why would you want to give gifts? Simply put, gifting can lower the estate tax burden for your heirs.

Most people never need to worry about the federal estate tax, but high-net-worth individuals and many business owners have larger estates to pass down, and the tax burden on the estate can be high.

For example, say you and your spouse have a home worth $3 million, a business worth $15 million, and other investments and real estate worth $20 million. Your total estate is worth $38 million. If you were to pass away in 2023, your estate would have to pay roughly $4.9 million in federal estate tax. That’s the taxable portion of your estate ($12,160,000) times the 40% maximum estate tax.

Gifting appreciating assets, including cash, investments and real estate, up to the annual and lifetime gift exclusion can reduce the value of your estate so you can transfer more wealth to your heirs.

Gifts that Don’t Count Toward Your Annual Exclusion

We’ve covered the exemptions and how you can use the tax rules to your benefit to lower your estate value and minimize tax burdens. Now, let’s look at the exceptions to the annual gift tax exclusion limit. Any money you give away that qualifies for one of these exclusions doesn’t count toward your taxable gifts and won’t chip away at your lifetime exclusion amount.

Medical Expenses

You can pay a person’s medical care directly to the provider, and the amount will not affect your annual or lifetime gift tax exclusion. 

Remember that this is only possible if you pay the medical bills directly. You can’t transfer the funds to the responsible party and have them pay the bill.

Tuition Expenses

You can also cover someone’s tuition expenses and not have the gift count toward the annual or lifetime exclusion limits. 

Again, you must pay the tuition directly to the educational institution, not to the individual. Also, this exclusion applies only to tuition—any money gifted for room and board, books, or other college expenses counts toward the limits.

Gifts to a Spouse

You can generally transfer an unlimited amount of property to your spouse without it counting toward your annual or lifetime gift tax limit. However, this only works if your spouse is a U.S. citizen at the time of the gift.

If your spouse is not a U.S. citizen, you would owe gift tax on anything over $175,000 for 2023 or $185,000 for 2024.

Estate Planning Tips To Protect Your Net Worth

The following tips can help you navigate the rules for gifted money and maximize your estate planning opportunities.

Start Early

The earlier you start estate planning, the easier it is to reduce your tax burden and make good decisions. 

For example, if you own a business, you can gift a fraction of the business to your children or grandchildren each year. This can be a helpful succession planning strategy.

Also, starting early means seeing the person receiving the gift enjoy it while you’re alive.

Take Advantage of Annual Gift Tax Exclusions

Work with your financial and tax advisors to create a plan to take advantage of the annual gift tax exclusions. This can include many gifts, such as contributing to a loved one’s 529 college savings plan, giving cash gifts to help with a down payment on a home, or transferring appreciated stocks or other investments.

Don’t forget to maximize your annual gift tax exclusions by paying directly for your loved ones’ college tuition or medical bills since these don’t count toward your annual exclusion amount. 

Consider Charitable Giving

To reduce your estate’s tax burden, consider charitable giving. Not only is this a philanthropic move, but it also lowers your estate’s value. 

One strategy to discuss with your financial advisors is donating appreciated stocks or other securities to charity rather than cash.

This helps you avoid capital gains tax and give more than you would if you sold the stock and then made a cash donation.

Maximize Lifetime Gift Tax Exclusions

Remember, you can give away more than the annual gift tax exclusion, but the difference between the gift’s fair market value and the annual gift tax exclusion will reduce your lifetime limit.

Work with your advisors to determine how much of your estate you should give away without creating a cash flow problem for yourself while you’re still alive.

Also, it’s essential to remember that the current lifetime estate tax exemption is temporary and applies only through 2025. Unless Congress makes the higher lifetime exemption amount permanent, it will revert to $5.49 million (adjusted for inflation) in 2026.

While there’s no way to predict what will happen between now and 2026, it’s worth discussing with your advisors whether you should take advantage of the higher exemption now if it disappears in a few years.

Get Personalized Advice on State Estate and Inheritance Taxes

We’ve covered the federal gift tax rates and rules, but each state has its own rules. Some states have an estate tax with a lower exemption amount, while some states levy an inheritance tax on heirs instead. Because rules and amounts vary from state to state, it’s important to discuss your situation with a professional familiar with your state’s laws.

Get Practical Guidance Navigating the Gift Tax Rules

Leveraging the gift tax rules and exclusions can be complex, and it’s essential to understand the annual and lifetime exemptions and what counts as a taxable gift.

If you need help deciding how to incorporate gift taxes as a part of your overall estate planning or filing gift tax returns, schedule a free consultation with Hood & Associates. We can help you interpret the tax rules and make the most of your annual exclusion.