It may come as a surprise, but generosity could come at a cost under certain circumstances. Specifically, if you give away something of value without getting something equivalent back in return, you could end up owing federal taxes based on the value of the property you transferred.
Gift taxes aren't owed for all property transfers, though. It's helpful to understand the gift tax rules so you can understand when giving to others may trigger IRS tax implications.
What is the gift tax?
According to the Internal Revenue Service, the federal gift tax is a tax assessed when someone who owns property transfers ownership without receiving something of equal value in return.
This gift tax is paid by the person who owned and transferred the property. It may be assessed regardless of whether the transfer was intended to be a gift or not.
All transferred property that could be classified as a gift must be declared on a gift tax return. This special tax form is due on the date of the April tax deadline in the year after the gift was made.
So if you provided someone with a gift in 2022, you would need to declare the gift on a gift tax return you submit by the April 2023 tax deadline. The best tax software could help you to file these IRS forms electronically.
What is considered a gift?
The IRS defines "gift" very broadly when determining when a transfer of property could trigger the gift tax. Specifically, a gift occurs when property of any kind is transferred either directly or indirectly to an individual without the giver receiving the full fair market value of the property in return.
A transfer of property could be considered a gift even if the giver didn't intend it to be. This property could be money or other assets such as real estate. It could even include the use of a property, income from a property, interest-free loans, or loans offered at a reduced interest rate.
What isn't considered a gift?
Although gift is defined very broadly, some types of property transfers aren't considered taxable gifts.
The IRS details some transfers that won't trigger gift tax, including the following:
- Gifts valued below the annual exclusion amount for the calendar year. Each year, the IRS sets a dollar amount limit on non-taxable gifts. If you keep the value of the property transferred below that limit, you won't owe gift taxes.
- Tuition that you pay for someone else if you pay it directly to the financial institution. Even if your payment exceeds the annual exclusion amount, it won't trigger gift tax obligations if the money goes right to the school instead of to the student first.
- Medical bills paid for someone else. Again, the money for the bills must be paid directly to the care provider. It cannot first go to the person who incurred the bills.
- Gifts made to your spouse. Any property transferred to a spouse isn't taxed, regardless of its value.
- Gifts to political organizations. These gifts won't count as taxable gifts, provided the political organization uses the funds.
Who pays the gift tax?
The gift tax is typically paid by the person making the gift. This is the individual who owned the property and transferred it to someone else.
In some limited cases, the recipient of the gift could agree to pay the tax. However, special arrangements must be made, and the IRS indicates it's best to talk with a financial advisor or professional if you'd prefer the gift recipient pay the tax.
What is the gift tax limit for tax year 2022?
As mentioned above, there is an annual exclusion amount. Taxpayers are allowed to give gifts valued up to that amount without owing any gift taxes. The exclusion is per giver and per recipient.
For example, if you had two children, you could give each of them a gift valued at up to the annual excluded amount. For tax year 2022, that amount is $16,000, so you could give each of your children $16,000 without being taxed.
If you and your spouse both give gifts, you could each give $16,000 per child for a total of $32,000 per child. This is sometimes referred to as gift splitting.
You also have a lifetime gift tax exclusion. This is the total amount you are allowed to give away both during your lifetime and after your death.
If you give a gift that exceeds the annual exclusion, you could either pay taxes on the value of the gift that exceeds that annual exclusion or you could apply it to your lifetime exemption.
If you chose the second option, that would reduce the amount you could transfer tax-free during the rest of your life and as part of your estate after you pass on.
The table below shows both the annual and lifetime exclusions, which can vary by year.
|Tax year||Annual gift tax exclusion||Lifetime gift tax exclusion|
What is the gift tax rate?
When you owe gift taxes, you are taxed at a different rate than you would pay on ordinary income taxes or capital gains. You pay the tax only on the value of the property that exceeds the annual exclusion limit.
For example, if you gave a gift of $20,000 in 2022, you would be $4,000 over the annual exclusion limit, so you would owe the gift tax on $4,000 unless you chose to apply the $4,000 to your lifetime exclusion. In that case, you would owe no taxes at all.
Here are the tax brackets that apply in tax year 2022 to the value of a gift that exceeds the annual exclusion.
|Taxable amount of gift above annual gift tax exclusion||Tax rate|
|$10,001 to $20,000||20%|
|$20,001 to $40,000||22%|
|$40,001 to $60,000||24%|
|$60,001 to $80,000||26%|
|$80,001 to $100,000||28%|
|$100,001 to $150,000||30%|
|$150,001 to $250,000||32%|
|$250,001 to $500,000||34%|
|$500,001 to $750,000||37%|
|$750,001 to $1,000,000||39%|
How to avoid the gift tax
You could avoid being hit with a gift tax by:
- Keeping the amount of your gifts below the annual exclusion
- Including the gift in your lifetime exclusion
- Paying medical expenses directly to a care provider
- Paying tuition directly to a school
- Giving gifts to a spouse or political organization, as these gifts are not taxable
What is the difference between the gift tax and the estate tax?
The federal estate tax is paid by your estate when property is transferred after your death. The gift tax is paid when you give a gift during your lifetime. Both during your lifetime and after your death, you are allowed to transfer a certain amount of property without owing taxes.
There is a unified lifetime exclusion that applies to gifts and estate taxes combined. The unified lifetime exclusion is valued at $12,060,000 in 2022. You are allowed to transfer this much property during your life or after your death without being taxed.
Surviving spouses are typically entitled to a marital deduction, which means assets aren’t typically subject to estate taxes as long as they’re U.S. citizens.
If you give a gift during your lifetime that exceeds the annual exclusion, you could choose to count the excess toward your lifetime gift tax exemption amount. That enables you to avoid taxes when the gift is given but reduces the amount you can pass tax free later on during your life or after your death.
What is the gift tax rate for a couple?
The gift tax rate is based on the value of gifts that exceed the annual exclusion amount. The tax rate is between 18% and 40% depending on the countable value of the gift.
Each spouse is allowed to give $16,000 per recipient in 2022 before this gift tax rate applies. This means a married couple could jointly give a gift valued at $32,000 per recipient before owing any gift taxes.
What is the rate for gifts given to a spouse?
Gifts to a spouse are exempt from gift taxes. You can give property of any value to a spouse without owing taxes on it.
Gift taxes have the potential to be expensive, but they could easily be avoided if you know how to manage your money wisely.
It's crucial to understand the tax laws for the annual exclusion amount and the lifetime exclusion to avoid owing the IRS money when transferring assets. If you are contemplating a large gift, it could also be helpful to get financial advice from an estate planning or tax professional on how to structure it to avoid owing taxes to the IRS.
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