A common question people ask is, what kind of taxes do I have to pay if I make a gift? Sometimes, we think of these as the gift tax. However, there are actually several types of taxes that could be paid when we make a gift. To understand taxable gifts, we need to look at each of the taxes and who has to pay them.
A gift tax is different than an estate tax, income tax, or capital gains tax. A gift is made while the giving person, called a donor, is still alive. If the gift is subject to a gift tax, the donor must pay the gift tax. Similarly, an estate tax is a tax paid by a decedent’s estate—since she is dead, the donor’s assets must pay an estate tax.
Gift tax exclusion limit
Most gifts are NOT subject to the gift tax. Only a gift of a certain size or larger on any given year might cause a taxable event.
For the latest information about the gift tax limits, visit the “Go Tax Free” area of our website. In 2022, gifts of less than $16,000 in value are not subject to the gift tax.
When a gift exceeds the annual gift tax exclusion limit, the donor must file a gift tax return. The gifts are tallied over her lifetime and compared against the lifetime exclusion, discussed next. If the total taxable gifts exceed that limit, then gift taxes must be paid by the donor.
The easiest way to avoid the gift tax is to keep the annual gifting below the annual gifting limits.
Over a person’s lifetime, the total amount of dollars that may be given without a gift tax is called the gift tax lifetime exclusion.
If the gifts to a single person in any year exceed the annual gift tax exclusion limit, then the donor must file a gift tax return. This return tallies all of the gifts from the donor to the recipients over time. The gift tax return must be filed by the donor every year until she passes away. The gift tax return is a nuisance.
If the total gifts exceed the lifetime exclusion, then the gifts could be subject to a large tax. At the time of writing, this is a 40% tax. The good news is that the lifetime exclusion limit is very high. In 2022, it is $12.06 million. This number is linked to the estate tax lifetime exclusion limit and both of them are indexed for inflation. So they are likely to increase, which is good news for donors!
Other taxes on gifts
We have discussed how the gift tax is a tax that the donor may have to pay. But there are also some taxes that the recipient may have to pay on that gift!
A gift made while the donor is still alive may force a recipient pay taxes. There are two types of taxes a recipient may have to pay: an income tax and/or a capital gains tax. To be clear, these taxes are paid by the recipient of a gift when the donor is still alive. These taxes are in addition to any gift tax that the donor may have to pay.
After the donor passes away
If the donor has already passed away, then the property has a step-up-in-cost-basis. This means the recipient could turn around and sell the inheritance with no tax obligations!
However, if the donor is still alive, there is no step up in cost basis. So a gift of highly-appreciated stock, for example, may cause the recipient to pay capital gains tax.
Ways to reduce the gift tax
A gift is made from one person to another person. So, a husband and wife who are feeling generous could double the size for their gift and still stay under the annual gift tax limit. In this case, the gift came from two people and each person is allowed to make a gift up to the annual limit.
Similarly, if the recipient is married, both spouses could receive a gift. In this way, the gift could also be doubled. A mother could give away twice as much to a married couple as she could give to a single person.
Even better, a married couple could give away four times the limit if the recipients are married. In a traditional family, this may look like this:
- Father to son (or daughter)
- Mother to son (or daughter)
- Father to daughter-in-law (or son-in-law)
- Mother to daughter-in-law (or son-in-law)
An important note: gender does not matter. For the gift tax exclusion limit, only a living person is important. Similarly, neither the recipients nor the donors need to be married. Each gift is from one person to another. As long as the total value of the gift is under the limit in each calendar year, then the gift tax can be avoided!
Additionally, gifts could be spread out over two calendar years. If a donor wants to make a large gift, they could give half in December (or any month) of this year and the other half in January of next year, and stay under the gift limits.
Applicable tax laws and for more information
The Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, increased the Gift tax in 2018 to $15,000. For 2022, the gift tax increased to $16,000. The exclusion amount is now indexed annually for inflation.
In 2026, the exclusion is scheduled to revert to its pre-2018 level. For more information, search the IRS.gov website. Here is a helpful link:
In summary, a gift tax is paid by the donor—the person making the gift. The recipient does not pay a gift tax, but may be subject to capital gains or income taxes on that gift. A gift tax is a Federal tax. Most gifts are not taxable, because the lifetime gift tax exclusion limit is more than $12million.
For further information, contact a wealth manager at A&I Financial Services LLC.