Understanding the Federal gift tax is essential for sound financial planning. This article aims to explain key concepts, debunk some common misconceptions, and outline some practical strategies for those who wish to incorporate gifting into their financial plan.
A gift is a transfer of property. The IRS considers a gift to be any transfer of cash or property where cash or property of equal value is not received in return. This generally comes in the form of cash or property but can also come in the form of below-market rent or interest.
Example: A parent rents their second home to their adult child for $1,000 per month, well below the market rate rent of $2,500 per month. Each month, the parent is making a gift of $1,500 to their adult child.
Gifts are not subject to income tax. The recipient does not ever pay income tax on gifts received during life, regardless of the size of the gift. Instead, gifts may be subject to gift tax, which is the responsibility of the giver.
Example: Charles receives a gift of $100,000 from his uncle. Charles does not need to report this gift on his income tax return.
Annual Exclusion. In 2023, a giver can gift up to $17,000 per person per year without it being considered a taxable gift. This annual exclusion is adjusted annually for inflation. Gifts in excess of $17,000 to a single person over the course of a year are considered taxable gifts. Note that married couples can elect “gift splitting”, which doubles the annual exclusion to $34,000. So long as a gift qualifies for the annual exclusion, a gift tax return does not need to be filed.
Example: A couple can give $34,000 in cash to their daughter. By electing “gift splitting”, the gift falls under the annual exclusion and there is no need to file a gift tax return (Form 709).
Gift tax returns only need to be filed by the gift giver if the amount of a gift exceeds the annual exclusion threshold. However, due to the lifetime exemption, filing a gift tax return does NOT necessarily mean that the gift giver will have to pay tax.
Lifetime exemption. In addition to an annual exclusion, the government also provides a lifetime exemption of $12.92 million in 2023 (also subject to change annually), which is the amount of “taxable” gifts a person is allowed to make without having to pay federal gift tax. Note that the word “taxable” in describing a gift does not necessarily mean that tax will be owed, just that it will count against the lifetime exemption. Also, the use of the lifetime exemption also counts against a person’s estate tax exemption, which is also $12.92 million.
Example: Bob gives a gift of $100,000 to his nephew. Bob will report the gift on a gift tax return (form 709). Of the $100,000, $83,000 will be considered a taxable gift, and his remaining lifetime exemption will be reduced by $83,000. In addition, his estate tax exemption will be reduced by $83,000. Assuming he has not used up his lifetime exemption, he will not owe any tax.
Certain types of gifts are completely exempt from gift tax considerations, including:
- Payments made directly to an education institution or medical provider on behalf of others.
- Gifts made to spouses, but not gifts to children!
- Payments made to charitable or political organizations.
Example: Grandparents would like to pay for the college tuition of their grandchildren. By making the payment directly to the education institution, the payment is exempt from gift tax considerations.
Recipients receive carryover basis tax treatment. Gifts of assets (such as real estate or stocks) maintain the cost-basis of the gift giver. This is called “carryover” basis. This is contrast to assets that are inherited, which are subject to a “step-up” in basis (to the value on the date of death or the alternate valuation date).
Example: A father gifts 200 shares of stock to his son on 9/30/2023. The value of the stock is $17,000 on 9/30/2023 and the cost basis is $10,000. There is no need to file a gift tax return as the gift falls under the annual exclusion amount and there are no income tax consequences to either party associated with the gift. Two years later, the son sells the stock for $25,000, and recognizes a capital gain of $15,000 ($25,000 sale price less $10,000 cost basis).
Whether you’re looking to provide financial support to loved ones, minimize your tax liability, or simply ensure that your financial affairs are in order, understanding the gift tax is a crucial step. At Core Wealth Management, we’re here to assist you in navigating this terrain and tailor a plan that aligns with your unique goals and circumstances.