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Updated on Thursday, April 1, 2021
When you give someone else a gift, you could be opening yourself up to possible tax consequences. The federal gift tax requires people to pay taxes on gifts that exceed certain amounts. A gift is considered anything of financial value, whether it’s cash, property, securities and more.
Thanks to annual and lifetime gift tax limits, most people won’t have to worry about these taxes. However, those who plan to transfer substantial wealth to loved ones might someday be subject to paying the gift tax.
- What is the gift tax?
- Gift tax limits for 2021
- What is considered a gift?
- Your estate and gift tax
- How to file a gift tax return
- What is the gift tax rate?
- How to avoid gift tax
What is the gift tax?
The gift tax is a federal tax that applies to transfers of property from one person to another when the giver doesn’t receive full value in return. Usually the person giving the gift pays the gift tax, though under some circumstances, the receiver may opt to pay the tax instead.
Gift tax limits for 2021
Thanks to both annual and lifetime exclusions, most people don’t have to worry about the gift tax. Individuals only have to file a gift tax return if they give more than $15,000 to another recipient per year and more than $11.7 million over their lifetime.
Annual gift tax exclusion
The annual gift tax exclusion in 2021 is $15,000, the same as it’s been since 2018. If you gift $15,000 or more to another person in a single year, you’ll have to file a gift tax return. The good news is that the $15,000 limit applies per individual, meaning you could give significantly more than $15,000 in a year, as long as you don’t give more than $15,000 to just one person.
The law also allows married couples to give more. Each partner can give up to $15,000, meaning as a couple, they can give $30,000 to another person before filing a gift tax return. Unlike your normal tax return, married couples can’t file a joint gift tax return — each spouse must file their own for their share of the gifts.
When you exceed your annual exclusion and file a gift tax return, any amount in excess of your annual exclusion is subtracted from your much-larger lifetime exclusion. It’s still unlikely that you’ll actually pay the gift tax, though. The lifetime exclusion allows people to give millions of dollars over their lifetime before paying gift taxes. However, the current lifetime exclusion is the result of a temporary increase in the 2017 Tax Cut and Jobs Act, and it could be drastically reduced in the future.
Lifetime gift tax exclusion
The lifetime gift tax exclusion in 2021 is $11.7 million, up from $11.58 million in 2020. The lifetime exclusion represents the amount individuals can give in excess of their annual exclusion before they have to pay gift taxes.
Most people will never reach their lifetime exclusion, meaning they won’t have to pay gift taxes. But according to estate planning attorney Eido Walny, it’s still something that should be on everyone’s radar in case of future policy changes, either under the current administration or another down the line, that will affect that current $11.7 million lifetime exemption.
“These may seem like really high numbers that almost no one would ever have to worry about, but these are historically high exemptions,” Walny said via email. “The Biden administration has taken the position that the $11.7 million exemption should be reduced to $3.5 million, for example. Historically speaking, the number was $675,000 in the year 2000.”
It is important to note that if you surpass your lifetime exclusion, you don’t have to pay gift taxes on everything you give. You still get an annual exclusion, meaning you only pay gift taxes on anything above and beyond $15,000 per recipient.
What is considered a gift?
According to the IRS, a gift is considered anything transferred from one person to another without full payment received in return. A taxable gift could include cash, but it could also include anything else of value, such as real estate, stocks, jewelry and more.
It’s important to note that something can be a gift even if some payment is received in return if it’s not the full market value.
“There is also a concept of a part gift/part sale that is often misunderstood,” Walny said. “If I have a home worth $250,000 and sell it to my son for $100, that is not a transfer for full consideration. So what I have done is sold part of my house for $100 and made a gift of $240,000, thus triggering the annual and lifetime gift exemptions into play. This should be avoided unless it is done strategically.”
Gift tax exemptions
There are some notable exceptions to the IRS definition of a gift, including:
- Gifts to your spouse
- Gifts to a political organization
- Gifts to a charitable organization
- Payments for tuition or medical expenses made on someone else’s behalf
Before you take advantage of these gift tax exemptions, there are a few things to consider. First, the exemption for gifts to your spouse only applies if you’re legally married. It doesn’t apply to those in a domestic partnership, civil union or similar formal relationship.
It’s also important to know that if your spouse isn’t a U.S. citizen, you are limited as to how much you can gift them. For gifts to non-citizen spouses, there’s an annual limit of $159,000 in 2021, up from $157,000 in 2020.
When it comes to gifts to charitable organizations, your gifts are only exempt from gift taxes if the organization meets the IRS definition of a qualified organization. Examples include community chests or trusts, war veterans’ organizations, domestic fraternal societies, churches, civil defense organizations and other nonprofit organizations. You can use the IRS Tax Exempt Organization Search Tool to ensure an organization is considered qualified.
Finally, there are certain restrictions to the exemption for tuition and medical expenses. First, the education exemption only applies to tuition — it doesn’t apply to room and board, textbooks or other costs associated with school. And in both the case of tuition and medical expenses, checks must be made directly to the organization or institution. You can’t simply give the money to a loved one for them to use for that purpose.
Your estate and gift tax
Any gifts you give in excess of your annual exclusion have implications beyond just potentially paying the gift tax. The gift tax and the estate tax are interconnected, meaning when you file a gift tax return and use up part of your lifetime exclusion, you’re increasing the amount of your estate that could be subject to estate taxes.
Here’s an illustration of how it works:
As of 2021, your lifetime exclusion is $11.7 million. Suppose that over the course of your life, you gift $5 million in excess of your $15,000 annual exclusions. As a result, you have $6.7 million of your lifetime exclusion left. When you die, anything in your estate above and beyond $6.7 million will be subject to estate taxes.
Remember that gifts only count against your lifetime exclusion when they exceed $15,000. If you had gifted just as much money over your lifetime, but in annual increments of less than $15,000, you would still have your entire $11.7 million lifetime exclusion left to decrease your chances of paying estate taxes.
How to file a gift tax return
If you exceed your annual exclusion of $15,000, you’ll have to file a gift tax return. This form — IRS Form 709 — is due by April 15 of the following tax year and should be filed with the rest of your annual federal tax return.
When you fill out Form 790, you’ll enter any taxable gifts you made throughout the year. You can also indicate whether you’re splitting the gifts with your spouse, enabling you to give twice as much as a couple as you can as an individual.
Keep in mind that filing the gift tax return doesn’t necessarily mean paying the gift tax. Any gifts you must file on your gift tax return reduce your remaining lifetime exclusion. It’s not until you’ve used up your entire lifetime exclusion that you must pay gift taxes on gifts that exceed $15,000.
If you’ve given gifts that require you to file a gift tax return, you may want to hire a tax professional because the form can be confusing,
What is the gift tax rate?
The gift tax rate you may be required to pay depends on the value of the gifts and ranges from 18% to 40%. To determine how much you could owe, find your taxable gift amount on the chart. Though remember, you’ll only have taxable gifts if you’ve gifted more than $11.7 million above your annual exclusions.
If your taxable gifts are less than $10,000, you’ll owe 18% on your entire taxable gift. If it exceeds $10,000, you’ll owe the amount in Column C for the lower tax brackets, as well as the tax rate in Column D for the highest bracket.
|Gift Tax Rates for 2020 and 2021|
|Column A||Column B||Column C||Column D|
|Taxable amount over||Taxable amount not over||Tax on amount in Column A||Rate of tax on excess over amount in Column A|
How to avoid gift tax
Most people will never have to pay the gift tax because of the lifetime exclusion. Even if you fear you might be subject to it someday, there are ways to get around it legally.
“Working with a knowledgeable estate planning attorney can help you minimize your gift and estate tax obligations with strategic planning,” said Monique Lavender Greeberg, an estate planning attorney. “We encourage many of our high net worth clients to use a strategic gifting program. This means they capitalize on the $15,000 annual exclusion gifts and make sure they make these gifts every year to their children, grandchildren and other beneficiaries.”
Ways you can avoid the gift tax include:
- Gifting $15,000 or less per person: Only gifts above your annual exclusion count against your lifetime exclusion. If you gift less than $15,000 per person, per year, then you won’t have to worry about using up your lifetime exclusion.
- Splitting gifts with your spouse: Each individual has an annual exclusion of $15,000, and couples can gift up to $30,000 per recipient without triggering the gift tax requirement.
- Making direct payments to institutions: Rather than writing a check to a loved one to help them cover the cost of college, consider writing the check directly to the institution itself, as it becomes an exempt gift.
- Giving consistently throughout your lifetime: Remember that the gift tax exclusion and estate tax exclusion are connected. By gifting just enough each year to avoid a gift tax return, you can slowly pass your estate down to your loved ones and avoid estate taxes when you die.