When an asset, such as property or cash, is transferred to another person without getting anything in return a gift tax may be applied. The asset has to be of a certain value for the tax to apply; otherwise, it falls under the gift tax exclusion, either annual or lifetime. If the gift is above a certain value you may still be able to avoid the tax, but you will have to complete and file a tax form commonly known as a gift tax return.
The value is based on the IRS definition of “fair market value.” If the asset is cash, then the calculation is straightforward: it is what it is. If the asset is a house, then its value is what someone would pay for it if neither buyer nor seller was under duress to commit. And some things which seem not to be gifted on their face may nonetheless be considered such by the IRS, for example, casual loans to friends and families, or naming someone other than a spouse on a bank account.
The current annual gift tax exclusion (as of 2021) applies to assets up to $15,000 in value. It is counted per recipient, meaning you can give up to $15,000 to however many people you like without having to file a gift tax return. It is also per person, so you and your spouse could gift up to $30,000 per year to a single person without having to file a gift tax return. Note that gifts between spouses are unlimited and don’t generally trigger a gift tax return and that giving money to a nonprofit is a charitable donation and not a gift. Finally, the person receiving the gift usually doesn’t have to report it.
The lifetime gift tax exemption is how you avoid the gift tax even if you give more than the annual exclusion amount described above ($15,000 per year, per person). To do this, you will have to file IRS Form 709, commonly known as a gift tax return. The gift tax return keeps track of the amount you have given. In 2020, the lifetime exemption in 2020 was $11.58 million; but was increased to $11.7 million in 2021.
The level of the lifetime gift tax exemption changes every year, but it might not always be higher. Under current law, it will continue to rise to cover the rate of inflation until the law sunsets at the end of 2025. At that time, the lifetime gift exemption amount will be lowered to $5 million per person, plus increases for inflation (effectively cutting the existing exemption amount at the end of 2025 in half). However, the lifetime gift exemption amount could be lowered to as low as $3.5 million per person sooner if the changes to the tax law supported by President Biden’s administration are passed into law. As such, it may be imperative for families to act now to make lifetime gifts while the lifetime gift tax exemption is so high or else risk losing an important ability to gift large amounts or assets of high value without incurring a gift tax.
As with the annual gift tax exclusion, the lifetime exemption exclusion is per person, so married couples can exclude twice the gifted amount over the course of their lifetimes or in the event of their death. Similarly, the lifetime gift exemption doesn’t apply to gifts between spouses because those gifts are unlimited.
In addition, it is important to know that there are exceptions and special rules for how to calculate the tax, which can be found on IRS Form 709. These apply to things like college tuition and medical bills by allowing you to spread one-time gifts across multiple years’ worth of gift tax returns, or to pay the institution directly to avoid the gift tax return requirement. Conversely, there are limitations and different amounts of annual exclusions and lifetime gift tax exemptions for non-citizen, non-resident spouses.
In conclusion, if handled correctly the gift tax will only apply once you use up not only the annual tax exclusion but also your lifetime gift exemption amount. For example, if you gift someone $50,000 this year, you will file a gift tax return to count the remaining $35,000 against your lifetime exemption. However, if you do manage to use up your lifetime exemption, the gift tax rates you would include a range from 18% to 40%, paid by you as the giver.
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Kevin Snyder is a husband, father, and an Orange County estate planning attorney and elder law attorney at Snyder Law, PC in Irvine, California. He's all about family and passionate about estate planning, elder law, and veterans. He founded Snyder Law to help people be prepared and have the peace of mind they are protecting their families and aging parents for when life happens.