Here's how you figure it out: Gifting the perfect gift to a loved one is one of life's greatest pleasures. And while giving gifts to family and friends has its advantages, there may be some unintended financial consequences. A gift tax of up to 40% is imposed by the federal government on transfers of property from one person to another, whether it is cash or a physical item. You may be required to file a gift tax return and pay the gift tax if the value of your gift exceeds a certain threshold.
What Is the Gift Tax and How Does It Work?
The gift tax is a tax that people must pay when they give something to someone else. According to the IRS, a gift is a property transfer from one person to another in which the giver does not receive payment for the full market value of the property. The gift could be in the form of cash, but it could also be in the form of other assets like stock or real estate. The gift tax was first enacted in 1924, then temporarily repealed in 1926 before being reinstated in 1932. It was created to keep wealthy families from avoiding estate taxes by transferring wealth to their children while they were still alive.Who is responsible for the Gift Tax?
In most cases, you won't have to pay taxes on gifts you receive from family and friends. The gift giver, not the recipient, is the one who must file a gift tax return (Form 709) and possibly pay the gift tax. Note: Special arrangements can be made in which the gift recipient agrees to pay the gift tax rather than the donor. If you're considering this arrangement, the IRS suggests consulting a tax professional for advice. When you transfer something of value from one person to another, it's usually pretty obvious when making a gift. However, there are some instances where someone may be transferring a gift without intending to do so. For example, if you give your child a gift, it is a taxable exchange. Your spouse is the only person to whom you can give a gift without incurring tax consequences. Even if the recipient makes a partial payment, something could be considered a gift. Assume a couple decides to sell their home to their adult child for $250,000, even though the home's fair market value is $500,000. Despite the fact that their child paid for the difference of $250,000 between the purchase price and the market value, it is considered a gift. The good news is that most gifts are exempt from the gift tax. Among them are:- On someone else's behalf, tuition or medical expenses are paid.
- Your spouse's gifts
- monetary contributions to a political party
- Donations to a good cause
- Lifetime Limits and Annual Exclusions
Exclusion for the Year
The yearly exclusion for the tax year 2021 is $15,000, but for the tax year 2022, it increases to $16,000. Individuals will not be required to file a gift tax return until they have given at least that much to another person in a single tax year. If you give someone $20,000 in 2021, for example, you'll have to file a gift tax return for $5,000, which is the amount over the annual exclusion. Keep in mind that the annual exclusion only applies to one person, so you can give much more than $15,000 per year if you give it to several people or organizations. It also indicates that a married couple can give up to $30,000 to another person without having to file a gift tax return, as each spouse is allowed to give up to $15,000 to another person. As part of the 1997 Tax Relief Act, the annual gift tax exclusion was indexed for inflation. The amount can be increased from year to year to keep up with the economy, but only in $1,000 increments. Exclusion has risen in 2002, 2006, 2009, 2013, and 2018, after remaining stable for several years.The Exemption for Life
The IRS also has a lifetime exemption that allows a person to gift an unlimited amount of money without having to pay gift taxes. Filing a gift tax return doesn't necessarily mean you'll end up paying gift taxes. The lifetime exemption for the 2021 tax year is $11.7 million, rising to $12.06 million in 2022. For example, if you gave someone $20,000, you'd have to file a gift tax return for $5,000, which is above the annual exclusion. That $5,000, on the other hand, would count toward your lifetime exclusion, so if you haven't used it up yet, you might not have to pay taxes on it. Large gifts made during your lifetime may have tax consequences after you pass away. Estates worth more than a certain amount are subject to the estate tax before being passed on to heirs. However, the gift tax exclusion and the estate tax exclusion are linked. For the tax year 2021, the $11.7 million lifetime exemption applies to both gift and estate taxes. Any gifts you make during your lifetime that reduce your lifetime exemption also lower the threshold at which your estate may be subject to estate taxes. Let's take a look at another scenario. Assume you give $3 million in excess of your annual exclusions over the course of your life. That money is deducted from your $11.7 million lifetime exemption. By the time you died in 2021, you'll have used up your lifetime exclusion of $8.7 million, and any portion of your estate worth more than that will be subject to estate taxes. Important: An increase in the 2017 Tax Cut and Jobs Act resulted in the current lifetime exemption. The increase will expire in 2025, after which the exemption will be reduced to $5.49 million, as it was before 2018.What Will the Gift Tax Be in 2021?
If you use up your lifetime exclusion and have to pay gift taxes, the rate you pay is determined by the value of the gifts that are taxed. The gift tax rate in 2021 will range from 18% (for the first $10,000 in taxable transfers) to 40% (for taxable transfers over $1 million). The following table shows the rate you'll pay for various gift prices:| Column A | Column B | Column C | Column D |
| The amount that is taxable: | Amount not subject to tax: | On the amount in column A, you must pay the following tax: | Excess over the amount in column A is taxed at a rate of: |
| $0 $10,000 $20,000 $40,000 $60,000 $80,000 $100,000 $150,000 $250,000 $500,000 $750,000 $1,000,000 | $10,000 $20,000 $40,000 $60,000 $80,000 $100,000 $150,000 $250,000 $500,000 $750,000 $1,000,000 - - - - | $0 $1,800 $3,800 $8,200 $13,000 $18,200 $23,800 $38,800 $70,800 $155,800 $248,300 $345,800 | 18% 20% 22% 24% 26% 28% 30% 32% 34% 37% 39% 40% |
What Is the Gift Tax and How Does It Work?
The gift tax rate you pay is determined by the amount you give in excess of your annual exclusion in a given year. Using an example is the simplest way to demonstrate this. Assume Janet gives $20,000 each year to each of her three adult children. Because her lifetime exclusion has been used up, everything above and beyond her annual exclusion is taxable. Her gifts are taxable at $5,000 per recipient, for a total of $15,000 in taxes. The first $10,000 she gives is taxed at 18 percent, resulting in a $1,800 tax. The following $5,000 is taxed at the next highest gift tax rate of 20%, resulting in a $1,000 tax bill. Janet owes a total of $2,800 in gift taxes for the year. The gift tax works similarly to income taxes in that each chunk of money is taxed at the rate that corresponds to the bracket in which it falls. The first $10,000 in taxable gifts is subject to an 18% tax, the next $10,000 to a 20% tax, the next $20,000 to a 22% tax, and so on.Main Points
- A tax called the gift tax is levied when expensive assets are transferred from one person to another.
- The gift tax rate can range from 18 percent to 40 percent, depending on the value of the taxable gift.
- To someone other than your spouse, a hospital or school acting on behalf of someone else, a political organisation, or a charitable organisation, give something for less than its full market value. You might be subject to the gift tax.
- People must only file a gift tax return after reaching the $15,000 annual exclusion for the 2021 tax year, and they must only pay gift taxes after reaching the $11.7 million lifetime exemption.
Most Commonly Asked Questions (FAQs)
What is the maximum amount you can give as a tax-free gift?
Individual taxpayers will be able to make a tax-free gift of up to $15,000 in 2021. There's also an $11.7 million lifetime exclusion, and any amount you give in a single year that exceeds $15,000 counts toward your lifetime exclusion, so your gifts won't be taxed until you reach that limit.What is the purpose of the gift tax?
The gift tax was implemented by Congress to stop wealthy families from transferring assets to loved ones during their lifetimes in order to avoid paying estate taxes.