When it comes to transferring wealth, the gift tax exclusion is a valuable tool for individuals looking to pass on assets without incurring significant tax liabilities. The gift tax is a federal tax on the transfer of money or property from one person to another without receiving something of equal value in return. However, the IRS provides an annual gift tax exclusion that allows taxpayers to give away a certain amount each year tax-free. Here’s a closer look at how this exclusion works and how you can use it to your advantage.
What Is the Gift Tax Exclusion?
The gift tax exclusion allows individuals to give gifts up to a certain amount each year without triggering the gift tax. For the tax year 2024, this annual exclusion amount is $18,000 per recipient. This means you can give up to $18,000 to as many people as you like within the year. Those gifts won’t be subject to the federal gift tax. Note that the person who makes the gift, known as the donor, is generally responsible for paying the gift tax.
How Does the Gift Tax Exclusion Work?
Each year, you can give a specific amount to any number of individuals without the gifts counting against your lifetime gift tax exemption. Here’s how it breaks down:
- Annual Limit Per Recipient: The exclusion applies on a per-recipient basis. For example, if you have three children, you can give each of them $18,000 in 2024 without owing gift tax. That means you could potentially gift $54,000 ($18,000 x 3) in one year without incurring any tax liability.
- Unlimited Gifts: You can give gifts to as many individuals as you wish. The exclusion applies separately to each recipient. This means you can give $18,000 to one person or 100 people in 2024 without paying gift taxes
- Joint Gifts for Married Couples: Married couples can combine their exclusions. If you’re married, you and your spouse can each gift $18,000 to the same person. This effectively doubles the exclusion to $36,000.
Lifetime Gift Tax Exemption
In addition to the annual exclusion, there’s a lifetime gift tax exemption. This is tied to the federal estate tax exemption. This is the total amount you can give away over your lifetime without having to pay federal gift taxes. For 2024, this lifetime exemption amount is $13.61 million per individual. If your gifts exceed the annual exclusion amount, the excess is deducted from your lifetime exemption. However, this only comes into play when you exceed the annual limit. Note that in 2026, the lifetime exemption amount will return back to pre–Tax Cuts and Jobs Act levels. This could mean an estimated $7 million in lifetime gift exclusion.
Gift Tax Examples
Here’s an example of how the gift tax works. If you gift $30,000 to a friend in 2024, you’ve exceeded the $18,000 exclusion by $12,000. That $12,000 would count against your lifetime exemption of $13.61 million. After this gift, your remaining exemption would be $13.61 million – $12,000 = $13,598,000. You would not owe gift tax until your cumulative gifts exceed this lifetime amount. However, you must file IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, to report this gift.
Let’s look at another example that involved exceeding the lifetime exemption. Let’s say you have already used up your $13.61 million lifetime exemption by giving large gifts over the years. In 2024, you give $1 million to your grandchild. The first $18,000 of this gift is covered by the annual exclusion. However, the excess amount of $982,000 ($1 million – $18,000) is now subject to gift tax, which has a marginal tax rate. In other words, the larger the gift, the more tax you’ll pay.
What Gifts Are Excluded?
Not all gifts count toward the annual exclusion. Certain types of payments are not considered taxable gifts, including:
- Direct Payments for Medical or Educational Expenses: If you make a direct payment to a medical provider for someone else’s medical bills or pay tuition directly to an educational institution, these payments do not count toward your annual gift exclusion.
- Gifts to Spouses: Gifts to your spouse are generally not subject to gift tax if your spouse is a U.S. citizen.
- Charitable Gifts: Gifts made to qualifying charities are typically not subject to gift tax.
Filing a Gift Tax Return
If you give a gift exceeding the annual exclusion amount to any recipient, you’ll need to file IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. This form tracks gifts made during your lifetime and any amounts that count against your lifetime exemption. However, filing this form doesn’t necessarily mean you owe gift tax; it’s simply a way for the IRS to keep track of the gifts you make.
Why Use the Gift Tax Exclusion?
The gift tax exclusion can be a powerful estate planning tool. By making use of the annual exclusion, you can reduce the size of your taxable estate, potentially lowering future estate taxes. It also allows you to pass on assets to your loved ones during your lifetime in a tax-efficient manner. If ever unsure how to proceed with gifts, you should consult a knowledgeable tax professional. Optima Tax Relief has over a decade of experience helping taxpayers with tough tax situations.
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