The gift tax is a federal levy on the transfer of money or property to another person when equal value is not received in return. While it may sound cumbersome, most Americans will never pay a cent in gift taxes to Uncle Sam due to several key Internal Revenue Service rules. However, a financial advisor or tax professional can help you determine what your tax liability may be if you plan to give money or property to another person.
What Is the Gift Tax?
When a person gives money or property to someone other than their spouse or dependent, they may be required to pay gift tax. This federal excise starts at 18% and can reach up to 40% on certain gift amounts. The responsibility for paying the tax typically lies with the donor, not the individual receiving the gift. While recipients don’t face any immediate tax consequences, they may have to pay capital gains tax if they sell gifted property in the future.
Not all gifts are subject to this tax, though. Certain gifts are entirely free of tax, including:
- School tuition and education payments
- Charitable donations
- Medical expenses
- Political contributions
- Gifts to spouses and dependents
The gift tax does not play a significant role in the finances of most Americans because of two key IRS provisions: the annual gift tax exclusion and lifetime exemption.
Annual Gift Tax Exclusion
The IRS allows individuals to give away a specific amount of assets or property each year tax-free. In 2022, the annual gift tax exemption is $16,000 (up from $15,000 in 2021), meaning a person can give up $16,000 to as many people as they want without having to pay any taxes on the gifts. For example, a man could give $16,000 to each of his 10 grandchildren this year with no gift tax implications.
But perhaps the same man chooses to give each grandchild $20,000, instead, exceeding his annual exclusion limit by $4,000 per gift. In this scenario, grandpa could potentially owe gift taxes on the $40,000 overage, but more on that in a bit.
What about married couples? Spouses can each give away $16,000 tax-free each year. This would allow Cynthia and Joe, a married couple, to give up to $32,000 to each of their three nieces and nephews every year.
Lifetime Gift Tax Exemption
If a gift exceeds the annual $15,000 limit, that does not automatically trigger the gift tax. The IRS allows a person to give away up to $12.06 million (up from $11.7 million in 2021) in assets or property over the course of their lifetime and/or as part of their estate. If a gift exceeds the annual exclusion limit, the difference is simply subtracted from the person’s lifetime exemption limit and no taxes are owed.
Consider this example: A woman decides to buy her granddaughter a $30,000 car as a college graduation present. Grandma would technically exceed the annual $16,000 exclusion limit per gift by a total of $14,000, but she wouldn’t owe additional taxes. That’s because she would report the gift to the IRS using a Form 709 and deduct $14,000 from her $12.06 million lifetime exemption. As a result, she would still be eligible to give away up to $12,044,000 tax-free.
|How the Lifetime Exemption Limit Works|
|Gift Value||2022 Gift Tax Exemption Limit||Taxable Amount||2022 Lifetime Gift Tax Exemption Limit||Remaining Lifetime Exemption Limit|
Note that for tax year 2021, because the gift tax exemption limit was $15,000 (and the lifetime gift tax exemption was $11.7 million), you would have still been able to give away $11,685,000.
However, it’s important to remember that a person’s lifetime exemption limit applies to gifts that a person gives while they are still alive and property they leave to heirs after they die.
How to Calculate the Gift Tax
As you can see, only people with millions of dollars to give away are subject to the federal gift tax. But if you’re one of those fortunate people, calculating your gift tax liability isn’t overly difficult.
Like federal income tax, gift tax rates are marginal, with the top rate reaching 40%. The larger a gift is, the more a person will potentially pay in taxes. But remember, you don’t have to pay gift taxes until someone exceeds their lifetime exemption.
After eclipsing this lifetime limit, taxes will be due on gifts that surpass the annual exclusion limit ($16,000 in 2022 and $15,000 in 2022). So, if a person who has already given away the lifetime exemption of $12.06 million ($11.7 million in 2021) to people other than their spouse and dependents decides to gift another $50,000, taxes would be owed on $34,000 ($35,000 in 2021) of that gift. To calculate their tax liability, the donor would use the following tax brackets:
|2022 and 2021 Federal Gift Tax Rates|
|Taxable Amount Exceeding Annual Exclusion Limit ($15,000 per gift)||Gift Tax Rate|
|$0 – $10,000||18%|
|$10,001 – $20,000||20%|
|$20,001 – $40,000||22%|
|$40,001 – $60,000||24%|
|$60,001 – $80,000||26%|
|$80,001 – $100,000||28%|
|$100,001 – $150,000||30%|
|$150,001 – $250,000||32%|
|$250,001 – $500,000||34%|
|$500,001 – $750,000||37%|
|$750,001 – $1,000,000||39%|
Using the above rates and brackets, the first $10,000 of this hypothetical gift would be taxed at 18%, the next $10,000 at 20% and the remaining $14,000 ($15,000 in 2021) would be subject to a 22% rate. In total, the donor would be responsible for paying roughly $6,900 in gift taxes on the $34,000 (and based on 2021 limits, this would have been approximately $7,100 in gift taxes on the $35,000).
Understanding the ins and outs of the federal gift tax can be important for the wealthy and generous, but most Americans will never face this tax. That’s because the IRS allows you to give away in 2022 up to $16,000 ($15,000 in 2021) in money or property to as many people as you like each year. The government also exempts $12.06 million in 2022 ($11.7 million in 2021) in gifts from tax over a person’s lifetime. However, if an individual gift does exceed the annual exclusion, you’ll need to file a Form 706 and report the gift to the IRS.
- Harvesting losses in your portfolio can reduce taxes on capital gains and a financial advisor can help you do it. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Understanding how capital gains taxes work is an important component of investing. Use SmartAsset’s capital gains tax calculator to determine how large your tax bill might be for certain transactions.
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