California does not levy a gift tax, however, the federal government does. That tax rate can climb to as high as 40%. Still, there are plenty of ways you can minimize the hit or avoid it all together. For the 2022 tax year, you can give up to $16,000 to any individual without triggering a gift tax, or up to $17,000 for the 2023 tax year. But even if you go over the limit, you may just need to file some extra paperwork come tax time. You won’t owe an actual tax until you exceed your lifetime gift and estate tax exemption. We’ll explain how that works, and how you can give without ever setting off a gift tax. But first, let’s define what a gift really is in the eyes of the IRS. We can also help you find a financial advisor to develop a personalized gift-tax strategy.
What Counts as a Gift in California?
The IRS defines a gift as virtually any movement of cash or property to another individual or entity without expecting something of equal or lesser value in return. This may include the following:
- Financial accounts such as bank, retirement or brokerage funds
- Assets such as stocks and bonds
- Property such as a home or a car
- No-or-low interest loans
As you can see, the definition can get a little vague. Suppose you made a loan to a friend with zero interest. If it was was large enough to buy a home, the IRS would consider it a taxable gift. It would also deem it a gift if you made that loan with an interest rate that falls below the IRS federal rates limits.
Selling property below market value may also affect your gift tax limits. Suppose you sell someone a home valued at $300,000 for $100,000. The IRS sees you made a gift of $200,000. However, you may still avoid paying a gift tax if you go above the annual exclusion limit of $16,000 for 2022 or $17,000 for 2023.
What Is the Annual Gift Tax Exclusion?
Every year, the IRS sets an annual gift tax exclusion. For 2022, the annual gift tax exclusion sits at $16,000. This applies per individual. So you can give $16,000 in cash or property to your son, daughter and granddaughter each without worrying about a gift tax. If you and your spouse make a gift jointly, the exclusion is $32,000. For 2023 the limit is $17,000.
But if you go over that limit for any individual or entity, you would need to report it on the IRS Form 709. Officially, it’s called the U.S. Gift (and Generation-Skipping Transfer) Tax Return.
Remember, filling this out doesn’t necessarily mean you have to pay a tax on the gift. The government made this rule in order to keep track of how you use up your lifetime gift and estate tax exemption.
Once your total lifetime gifts exceed that threshold, the IRS requires you to pay an actual gift tax.
How Does the Lifetime Gift and Estate Tax Exemption Work?
Remember, the annual gift tax exclusion for 2022 stands at $16,000 and $17,000 in 2023. So feel free to transfer gifts valued in this amount to any number of individuals, each without worrying about taxes.
But if you go above that threshold for a particular person, you begin to reduce your lifetime gift and estate tax exemption of $12.06 million (as of 2022) or $12.92 million (as of 2023).
Think of the “annual exclusion” and “lifetime exemption” as buckets of water. If you fill one up (annual exclusion), it runs over into the next one (lifetime exemption). Once you fill the latter, that’s when Uncle Sam steps in.
The IRS can levy a federal gift tax on what spills out of that lifetime exclusion bucket. The gift tax rate can climb to 40% depending on how much of that money exceeds your lifetime exemption.
How Does the California Estate Tax Work?
Fortunately, there is no California estate tax. However, the federal government enforces its own. If the property you left behind to your heirs exceeds your lifetime gift and estate tax exemption of $12.06 million in 2022 or $12.92 million for 2023, you’d owe a federal estate tax on the portion that exceeds those thresholds. The estate tax rate can climb to as high as 40%.
But with help from a qualified financial advisor and attorney, a married couple can shield about twice as much from the federal government. In addition, there are ways you can steer clear of a potential estate-tax hit by taking some important steps.
Reducing the Size of Your Estate
In a nutshell, the federal government levies an estate tax on very large estates. So if you’re worried about facing a potential hit, it may behoove you to reduce the size of the estate you leave behind. This may ensure your loved ones take full advantage of what you leave behind for them.
One path you can take is establishing an irrevocable trust and naming your choice of beneficiaries. Assets in an irrevocable trust can be passed on to your beneficiaries after your death. But while you’re transferring money or property into the irrevocable trust, those assets technically leave your ownership. Thus, they effectively reduce the size of your taxable estate.
Plus, you can build a trust with virtually anything of value. For example you can invest in mutual funds and other securities. This means the money can grow over time before it reaches your beneficiaries.
This strategy may help prevent you from eating into your lifetime gift and estate tax exemption. As long as what you transfer toward the trust each year doesn’t exceed the annual gift tax exclusion at the time, you can steer from reducing your lifetime exemption.
When it comes to strategizing your estate planning and avoiding the gift tax in general, that’s your primary goal. Gifting in moderation each year without exceeding the annual exclusion helps you avoid breaching the lifetime exemption.
But trusts and estate planning strategies can get extremely complicated. This is why the guidance of an experienced financial advisor and tax professional is crucial in these situations.
Nonetheless, there are some instances where you can give as much as you want and it won’t count as a gift.
What Doesn’t Count Toward the Gift Tax?
Below, we cover some of the individuals and entities you can give as much as you want to without triggering a gift tax. This means these gifts won’t reduce your lifetime gift and estate tax exemption.
Spouse: You can transfer any amount of cash and property to your spouse tax-free as long as he or she is a U.S. citizen. If your spouse is not, the IRS sets an annual limit to what you can give tax-free. For tax year 2022, it’s $164,000, and for tax year 2023 it’s $175,000.
Charity: If you donate toward a registered non-profit organization, the IRS may not treat it as a taxable gift. Check with a financial advisor or tax professional to see which organizations count for the exemption as this may vary across states.
Medical Institution: If you cover someone else’s bill for qualified medical expenses, it may be a non-taxable event. However, you have to send the payment directly to the caregiver. If you’re planning on doing this, you should seek the guidance of a tax professional.
Educational Institution: Suppose you want to cover your child’s tuition bill. As long as you send the payment directly to the school, you won’t cut into your gift-tax lifetime exclusion. But you may if you send it directly to the student. Also, keep in mind this applies to only tuition. Nonetheless, you can use a 529 college savings plan to save for other qualified educational expenses such as books. These savings vehicles also enjoy their own gift tax exemptions.
The 529 Plan Gift Tax Exemption
If you’re investing in a 529 plan toward a beneficiary such as your son or daughter, you’re technically making gifts. However, the IRS allows you to contribute up to $85,000 without cutting into your annual exclusion as long as you agree to not make any more contributions toward a 529 plan for the same beneficiary in the next five years.
In essence, the IRS lets you use five years worth of annual exclusions for this beneficiary at once as long as it goes toward a 529 plan. For 2023, that’s $17,000 multiplied by 5, or $85,000.
If you choose to contribute less than five years, it’s pro-rated. So if you contribute $34,000 ($17,000 x 2), you’ve used up two years of your annual exclusion. And therefore you can’t contribute toward the plan for the next two years instead of five.
The great thing is that the move would not eat into your lifetime exemption or whatever the amount is at any given time. If you simply gave the beneficiary $85,000, you would reduce your lifetime exemption because you gave an individual more than $17,000 in one year.
But what if your son or daughter is in college and you don’t have an active 529 plan in their name? You can always send money directly to the school to cover tuition. Plus, you can send up to $17,000 directly to each student to cover other educational expenses. Neither move requires you to report it to the IRS. And neither lowers your lifetime exemption.
California doesn’t enforce a gift tax, but you may owe a federal one. However, you can give up to $16,000 in cash or property during the 2022 tax year and up to $17,000 in the 2023 tax year without triggering a gift tax return. If you gave more than $11.58 million in 2020 or give more than $11.7 million in 2021, you’d owe a gift tax. In 2022 the lifetime gift and estate tax exemption is $12.06 million and for 2023 it is $12.92 million. The tax rate can climb to 40% on the portion that exceeds that limit. But there are plenty of steps you can take to avoid gift and estate taxes.
Tips on Avoiding Gift Tax
- Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve 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.
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