The gift tax exclusion is among the most valuable tools available to transfer assets to family and other loved ones without ending up with an unwelcome tax bill for the givers or recipients. Year end often is a busy time for gifting, as taxpayers move to take advantage of the annual exclusion. However, the impending end of the increased lifetime exemption offers another incentive to act now.
The federal estate tax rate ranges from 18% to 40%. Annual gifting can be an effective strategy to reduce the size of your taxable estate. The savings may be significant, especially when you transfer assets that are expected to appreciate over the short run or are subject to substantial valuation discounts (for example, for lack of marketability or control).
For 2023, the annual gift tax exclusion is $17,000 for each recipient. The IRS doesn't impose any limit on the number of individuals to whom you can make tax-free gifts. And, if you're married, your spouse can gift another $17,000 to the same recipients, doubling your gifts and reducing your combined estate by $34,000 for each recipient.
Note: For 2024, the annual gift tax exclusion will increase to $18,000 for each recipient.
That can add up. For example, if you and your spouse each make gifts to your 10 grandchildren in 2023, you can remove $340,000 from your estate. And you can more than double the amount you remove from your estate by making gifts in both December 2023 and January 2024.
If you make gifts to someone other than your spouse this year that exceed the $17,000 limit, you'll need to file IRS Form 709, "United States Gift (and Generation-Skipping Transfer) Tax Return." You and your spouse must file separate returns — no joint return is available for gift taxes. You must file a separate return for each calendar year a reportable gift is given.
Lifetime Exemption Scheduled to Change
If you make gifts that exceed the annual exclusion, you aren't required to pay taxes, but you'll reduce the amount of your lifetime gift and estate exemption that's available at your death. For 2023, the federal exemption is $12.92 million ($25.84 million for married couples). The estate tax generally is computed by adding taxable gifts to the deceased person's gross estate and then reducing that figure by the lifetime exemption in effect at death.
Note: For 2024, the federal lifetime gift and estate exemption increases to $13.61 million ($27.22 million for married couples).
The Tax Cuts and Jobs Act of 2017 nearly doubled the exemption. But the provision is scheduled to sunset after 2025, absent Congressional action. At that point, the exemption would return to its previous level of $5 million (adjusted for inflation). In 2019, the IRS issued a final "anti-clawback" regulation that will allow post-2025 estates to calculate taxes based on the lifetime exemption in effect at the time large gifts were made (assuming they're made from 2018 through 2025), rather than the smaller limit that may be in effect at the time of death.
Important: Some states impose estate or inheritance tax at a lower threshold than the federal government does. So it's also important to understand the rules in your state to avoid an unexpected tax liability or other unintended consequences of an asset transfer.
Not every asset transfer is a "gift" in the eyes of the IRS. Generally, the federal gift tax applies to any transfer by gift of real or personal property, tangible or intangible, that you made directly or indirectly, in trust, or by any other means. Examples include:
Stocks and bonds,
The gift tax doesn't just apply to the free transfer of property. It also may apply to certain sales or exchanges where, for example, the value received is less than the value of the property sold or exchanged. Other situations where it may apply include:
Forgiveness of debt,
Interest-free or below-market interest rate loans,
Transfer of benefits from insurance policies,
Property settlements as part of divorce litigation, or
Annuities in exchange for creating survivor annuities.
The gift tax applies to digital assets, too. The IRS defines digital assets as any digital representations of value that are recorded on a cryptographically secured distributed ledger (for example, blockchain) or any similar technology. For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins.
On the other hand, the gift tax doesn't apply to tuition that you pay on behalf of another person. The payment must be made directly to the qualifying educational organization and for only tuition. No educational exclusion is allowed for books, supplies, room and board, or other expenses that aren't direct tuition costs.
Contributions to a 529 plan also aren't excluded from the gift tax. However, you can accelerate up to five years' worth of annual gift tax exclusions to make a large 529 contribution in a single year. In 2023, an accelerated contribution will max out at $85,000 ($170,000 for a married couple).
Similarly, medical expenses paid on behalf of another person are excluded from the gift tax if they're paid directly to the medical provider. The expenses must qualify for the medical expense tax deduction, and the exclusion doesn't apply to costs reimbursable by the person's insurance.
Although the annual gift tax exclusion is expected to continue for the long run, the clock may be ticking on the generous lifetime exemption. We can help you with an estate plan that maximizes the benefits for you and your loved ones.
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