Minnesota no longer has its own gift tax but it does have an estate tax. You may still owe a gift tax at the federal level if you exceed your lifetime gift and estate tax exemption. The Tax Cuts and Jobs Act signed into law by President Trump raised that limit. We’ll explain exactly how gift taxes work and what you need to watch out for. We’ll also explain how to make non-taxable gifts and steer clear of a potential gift tax. Consider working with a financial advisor who can guide you through the entire estate planning and charitable giving process.
What’s a Gift When It Comes to Taxes?
In the eyes of the IRS, a gift is virtually any cash, assets, or property that you give to another individual without expecting to get anything of equal or greater value in return. This can include the following:
- A residence or building
- A vehicle, plane or boat
- Family heirlooms
What Is the Annual Gift Tax Exclusion?
While there is a federal gift tax, some states also enforce their own. Minnesota, though, repealed its gift tax several years ago. So you’d only need to worry about the federal one if the gifts you make exceed a large amount in value. We’ll explain.
Every person has an annual gift tax exclusion. You can provide gifts valued at this amount to any individual without worrying about Uncle Sam. The Trump Tax Plan increased the annual gift tax exclusion to $16,000 per person for the 2022 tax year and $17,000 for the 2023 tax year. Also, the Trump law raised the lifetime gift and estate tax exclusion for individuals to $12.06 million for 2022 and to $12.92 million for 2023.
That means you can give any number of individuals gifts worth up to but not above the exclusion without even having to report it. This threshold typically increases each year to keep in line with inflation. But if your gift to someone exceeds the threshold, you’d need to fill out IRS Form 709 come tax season. Officially, this is called the U.S. Gift (and Generation-Skipping Transfer) Tax Return.
But when you provide someone with a gift valued at more than that annual gift tax exclusion, you begin to reduce your lifetime gift tax exclusion by the amount of the overage.
How Does the Annual 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.
Moreover, the state of Minnesota applies its own estate tax. This is why seeking help from a financial advisor versed in estate planning can be a greatly beneficial move for Minnesotan families.
What Is the Minnesota Estate Tax?
As you can see, the federal government starts taking a cut from the portion of your estate that you pass on to heirs if it’s valued above a certain threshold. That’s the same case with the Minnesota estate tax.
For 2023, the exclusion amount and tax filing threshold is $3 million. And for decedents, Minnesota sets the maximum qualified small business property and farm property deduction at $2 million.
So in essence, one way to protect what you leave behind to your loved ones from the government is by reducing the size of your estate while you’re alive. A qualified financial advisor can guide you through this process based on a strategy tailored to your personal financial goals.
But we’ll cover some common practices you may be interested in.
Reducing the Size of Your Estate
One way you can reduce the size of your taxable estate while you’re alive is by taking advantage of your annual gift tax exclusion. You can currently give $17,000 to any number of individuals without having to report your gifts to the IRS. In other words, you can give this amount to your children and grandchildren, for instance, without having to worry about taxes.
But what if you feel they’re too young to manage such a large sum on their own? You can always set up a trust fund and designate them as beneficiaries. With an irrevocable trust, for example, the assets in the trust won’t be transferred to your children until after you pass away.
And when you transfer assets toward an irrevocable trust, those assets cease being yours in the eyes of the IRS. This move effectively reduces your taxable estate. The transfer itself would count as a gift, however. But you can steer clear of the gift tax if you stick to the annual exclusion and watch your lifetime exemption.
You can also choose a trustee such as a qualified financial professional to manage trust assets in the best interest of your beneficiaries.
But because there are so many types of trusts out there with their own rules and legal stipulations, you should establish one with the guidance of an attorney and financial advisor with an expertise in estate planning.
What’s Not Subject to the Gift Tax?
When you make a gift toward certain individuals or entities, the IRS won’t treat the move as a taxable event regardless of that gift’s value. This means these gifts won’t put a dent in your lifetime gift and estate tax exemption. We explain some of those instances below:
Spouse: You can give as much as you want to your husband or wife without worrying about gift taxes as long as your spouse is a U.S. citizen. Otherwise, you have an annual limit. For tax year 2022 (what you’d file for in 2023), that limit was $164,000. For tax year 2023, the figure moved to $175,000.
Medical Expenses: You can avoid the gift tax if you cover a qualified medical expense on behalf of someone else. However, you have to send the payment directly to the person providing care in order to make it legitimate. Qualified expenses include the following, but you should seek a tax professional for the finer details:
- Disease diagnosis and treatment
- Medical insurance
- Transportation required primarily for medical care
Educational Expenses: When you send a payment to an educational institution to cover someone else’s tuition costs, the IRS doesn’t consider it as a taxable event. It will, however, if you send it to the student. And keep in mind that this applies to tuition only. Other educational expenses such as books and mandatory fees don’t count. However, you can cover these expenses by contributing toward a 529 college savings plan on behalf of someone else. The IRS also allows special gift tax exemptions when it comes to these types of plans.
529 Plans and Gift Tax Exemptions
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 $80,000 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. In 2022, the annual exclusion was $16,000, or $80,000 in five years.
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.
What Else Should I know About the Gift Tax?
While the lifetime gift and estate tax exemption rose dramatically thanks to the Tax Cuts and Jobs Act, it’s scheduled to expire at the end of 2025. So on Jan. 1, 2026, it may revert back to its pre-2017 level of $5.49 million for individuals.
And while individuals have to report a gift that exceeds the year’s annual exclusion amount, couples making joint gifts have to report all of these even if they don’t exceed $17,000.
While Minnesota doesn’t currently have a gift tax, the federal government does. However, you get to make gifts valued at up to a set limit ($16,000 in 2022 and $17,000 in 2023) to any number of individuals without worrying about gift taxes. This is known as the annual gift tax exclusion, which can change from year to year. On Jan. 1, 2026, it is set to revert to its pre-2017 level of $5.49 million for individuals. When you exceed the annual gift tax exclusion, you begin to reduce your lifetime gift and estate tax exemption. Nonetheless, you’re subject to paying an out-of-pocket gift tax only when you surpass the applicable lifetime gift and estate tax exemption amount.
Tips on Avoiding Gift Tax
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