It feels good to give, but getting taxed on your generosity — not so much. Though a gift tax exists on the federal level, most people don’t need to worry about it. The gift tax rate can run as high as 40%, but fortunately, most people won’t pay that much.
Whether you’re curious about gifting money to children or donating to charity, here’s what you need to know.
What is the gift tax?
The gift tax is a federal tax on the transfer of property from one person to another. The gift tax won’t affect most people since it mainly exists to prevent large transfers of wealth. You are able to gift an individual up to $17,000 a year as of 2023 and can give that amount to as many people as you want.
Even if you exceed the annual exclusion amount, any excess gifts go towards your lifetime exclusion amount, which is $12.92 million in 2023. This means you likely won’t pay a dime of gift taxes unless you give away millions of dollars.
What is considered a gift?
There may come a time when you want to gift money or property to someone, such as your children, grandchildren, or charity. A gift is defined as the transfer of property where nothing is received in return.
Gifts that can incur taxes include:
- Real estate
- Any other item that has value
Certain donations are not considered gifts, such as:
- Gifts under the annual exclusion amount
- Tuition paid directly to an educational institution
- Medical expenses paid directly to a medical facility
- Gifts to your spouse (as long as the spouse is a US citizen)
- Gifts to a political organization
- Charitable donations
Who pays the gift tax?
Generally, the one giving the gift (donor) is responsible for paying the gift taxes, not the person who receives the gift (donee). The same rules apply whether or not the recipient of the gift is related to the donor. Gifts between spouses are typically exempt from gift taxes.
Fortunately, gift taxes are not an issue for most people due to the annual and lifetime exclusion amounts.
Here’s how gifting impacts different types of taxes:
All gifts, regardless of value, have no income tax consequences to the donor (person making the gift) or the donee (recipient of the gift). This is because gift taxes are considered a transfer tax, not an income tax.
The gift is not included in the taxable income of the person who receives the gift. The person providing the gift does not get a deduction on their income tax return for making the gift.
Estate and gift tax
The estate and gift tax is unified. If a gift to another individual is made during a calendar year in excess of the annual exclusion amount, the donor has an obligation to report the gift on a federal gift tax return (IRS Form 709). Any amount you give in a year over the annual exclusion amount must be reported on a gift tax return so it can be applied to your lifetime exclusion limit.
For example, say a donor makes a $117,000 gift to a donee in 2023. The donor must file a federal gift tax return to indicate to the IRS that the donor has used $100,000 of their $12.92 million estate tax exemption. No tax is due with this gift tax return, but the amount still needs to be recorded.
What is the annual gift tax exclusion?
The annual gift tax exclusion is the amount someone can gift another person without incurring gift taxes. The amount can change from year to year, but as of 2023, the annual exclusion amount is $17,000 per recipient, not in total.
Let’s say you have a son and a daughter, and you want to give them a cash gift. You can give each of them $17,000 per year, you don’t need to divide the amount between them, and the exclusion amount resets every year.
Additionally, you can give the full $17,000 all at once or spread out throughout the year. You do not have to be related to someone to give them a gift. The annual exclusion amount is also per person, which means if you’re married, you and your spouse can give a total of $34,000 to one individual.
If you donate more than $17,000 a year to one individual, you must file a gift tax return (IRS form 709) to disclose the amount. Anything reported on form 709 will be applied to your lifetime gift tax exclusion.
Filing a gift tax return doesn’t necessarily mean you owe taxes. If you do owe taxes, you will owe 18-40%, depending on the size of the gift. The purpose of the 709 form is to keep track of gifts you make that are above the annual exclusion amount.
So, the bottom line is if you want to avoid paying gift taxes, stay under the annual exclusion limit as well as the lifetime exclusion limit ($12.92 million in 2023). If you stay under the thresholds, you will be able to give without the hassle of filing a gift tax return and potentially owing taxes.
Unless you give millions of dollars in your lifetime, you likely won’t owe gift taxes. If you do exceed the exclusion limits, the gift tax could be as high as 40%. If you do want to give that much, it’s important to plan ahead for the tax implications.