It’s the giving season, and for most of us, gift giving doesn’t come with notable tax ramifications. However, for those planning on handing out particularly generous gifts, additional planning may be necessary to account for taxes – gift taxes, specifically.
Here, Hap May our tax attorney, will address what to expect with gift taxes, whether your gift is taxable, and what people can do to reduce any tax liabilities associated with gift giving.
The Legal Definition of a Gift
To be considered a gift for taxation purposes, the transaction in question must include the following three elements:
- Intention – To meet the legal definition of a gift, whatever you give must be given freely, without expectation of a return. To put it in holiday terms, if you’ve gone to the store to buy a new pair of earrings (or necktie) for your spouse, you’ve satisfied the intention prong of the definition.
- Delivery – Delivery means you’ve given over possession of the gift to the receiver. This could be physical possession, as in you’ve wrapped up the gift and put it under the tree. It could also mean constructive possession, as in you’ve given control of the gift to the other person, even if they don’t currently possess it physically.
- Acceptance – Acceptance means the other person claims possession of the gift, without obligation of any return. When your spouse opens their new pair of earrings (or necktie) and shows delight, they have expressed acceptance.
If intention, delivery, and acceptance are all expressed when you hand over the present, you’ve provided a gift from the IRS’s perspective. That’s when tax laws kick in.
What is and is not considered a taxable gift by the IRS?
Even if a gift meets the above definition, that doesn’t automatically mean that the IRS will tax it. There are several exceptions to the IRS’s own rules, as the following gifts are not taxable:
- Gifts to a spouse
- Education expenses
- Medical expenses
- Gifts to a political organization
Broadly speaking, anything not covered by the above is a taxable gift. That includes cash, property, real estate, and securities.
Gift Taxes: Rates, Annual Exclusions and Lifetime Exclusions
Gift tax rates are governed by the gift’s value. The greater the value, the higher the rate. Assuming you have exceeded your exclusions (as explained below), gift taxes start at 18 percent and increment up to 40 percent. The very first dollar over your exclusions is taxed starting at 18 percent, and the rate increases as the value of the gift increases. The top bracket (40 percent) starts when a gift’s value exceeds $1 million.
For the majority of people, gift taxes are rarely a cause for concern due to the annual and lifetime exclusions. Until these exclusions are exceeded, you’ll owe zero tax on the gifts you give out. Here’s how each exclusion factors in:
- The annual exclusion – For 2023, the annual exclusion is $17,000 per recipient. In other words, you can give $17,000 to any one person before the annual exclusion is exceeded. Because this is an annual exclusion, it resets when the tax year rolls over. For 2024, the exclusion will increase to $18,000. So, you could give your best friend $17,000 in 2023 without reporting it to the IRS, and then give that same friend $18,000 in 2024 without reporting it to the IRS.And because this is a per person exclusion, you could give $17,000 each to multiple people without triggering the exclusion limit.
For married couples, the annual exclusion limit is essentially doubled. For 2023, a married couple may gift a total of $34,000 between them to any single individual before exhausting both spouses’ annual exclusion limits.
Any amount over the annual exclusion is then subtracted from the taxpayer’s lifetime exclusion.
- The lifetime exclusion – Just because a taxpayer exceeds their annual exclusion, that doesn’t necessarily mean they start paying gift taxes. First, the taxpayer’s lifetime exclusion must be exhausted. For 2023, this limit was set at $12.92 million. In 2024, it’s set to go up to $13.61 million.If your gift to an individual exceeds your annual exclusion, any excess is subtracted from your lifetime exclusion. Unlike the annual exclusion, your lifetime exclusion is not based on a per-individual basis. Put another way, if you give $20,000 to one friend and $20,000 to another, you’ve exceeded the per-individual annual exception by $3,000 with two people. As such, a total of $6,000 will be deducted from your lifetime exclusion.
As you can see, gift taxes are generally a concern for those with high-value assets or estates.
How to Reduce Taxes When Giving Large Gifts
The key to minimizing gift taxes is planning in advance. If you’re expecting to leave behind a large estate, or other considerable assets, planning early will allow more of your assets to pass to loved ones without the IRS getting involved. Specifically, most gift tax strategies involve the following:
- Gift splitting – Instead of waiting and handing over a large gift in the future – one that will easily exceed your annual exclusion – consider giving smaller gifts over many years. If you are married, ensuring gifts are made in both spouses’ names can double the value of your gifts, allowing people to transfer a lot of wealth tax-free, if the annual exclusion is fully leveraged year over year.
- Special trust instruments – Individuals can provide gifts in excess of the annual exclusion without paying taxes by establishing a special kind of trust – the Crummey trust. Named after the attorney who first developed the instrument, the Crummey trust skirts around the IRS’s “present interest” requirement for a gift to be considered a gift. That’s because the funds placed in a Crummey trust may be accessed by the beneficiary for a short time, satisfying the intention and delivery prongs of the IRS’s definition of “gift.”There are also provisions in some 529 education savings plans that allow gift givers to spread the value of their 529 plan gift over multiple years. This can help taxpayers stay under the annual exclusion.
If You’re Unsure of the Laws of Gift Giving, a Reputable Attorney Can Help Clear Up Questions
The above tax strategies can be complicated without a precise estate planning vision in place. A trusted tax and estate planning attorney can provide valuable insight in this area, helping estate owners gift what they want to who they want, with minimal tax ramifications.
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