North Carolina does not have a gift tax. However, you may trigger a gift tax at the federal level depending on the value of the gifts you provide. But you won’t owe a gift tax until you breach your lifetime gift and estate tax exemption. The Tax Cuts and Jobs Act signed by President Donald Trump raised that threshold. For individuals it is $12.92 million for 2023. Nonetheless, you may still have to report some gifts that fall far below that value in order to avoid trouble with the IRS. A financial advisor can help you with tax issues and estate planning. Let’s break down how the gift tax works and which steps you can take to avoid triggering it.
North Carolina Gift Tax History
Before we get into the nitty-gritty of gift taxes, let’s define what a gift actually is in the eyes of the IRS. A gift is basically anything of value that you transfer to another individual or entity without expecting anything of equal or greater value in return.
The federal government levies a gift tax once you provide gifts that exceed a certain value. Some states enforce their own gift taxes, as well. North Carolina, however, did away with this back in 2009. So you only have to worry about the federal gift tax. Nonetheless, you have some exclusions.
What Is the Federal Annual Gift Tax Exclusion?
Everyone gets an annual gift tax exclusion. This is the dollar amount value in gifts you can provide to each individual without having to worry about taxes. The Trump Tax Plan raised that threshold to $17,000 for 2023.
But don’t worry if you give away more than that during those years. If during 2023 you went the $17,000 gift tax limit, you most likely would just need to file some extra paperwork come tax season. For instance, you’d need to report the gifts that totaled more than $17,000 in value per individual (or whatever the annual gift tax exclusion is at the time).
You must report the gifts that exceed the annual exclusion on IRS Form 709, officially known as the United States Gift (and Generation-Skipping Transfer) Tax Return.
The IRS requires this to keep track of your lifetime gift and estate tax exemption. Once you breach that threshold, Uncle Sam comes for a slice.
You’re probably wondering why there are two different tax limits: the annual exclusion and the lifetime exemption. We’ll do away with the jargon and break it down in plain English.
How Does the Annual Gift and Estate Tax Exemption Work?
The annual gift and estate tax exemption is the dollar amount worth of gifts that you can give away in your lifetime before you have to pay an actual gift tax. This amount can vary from year to year. But, for individuals, the Tax Cuts and Jobs Act raised that to $12.92 million for 2023.
The annual exclusion is the amount you can give away each year without having to report it. But once you breach that level in any given year, you begin to cut into the lifetime exemption. So let’s say you give away $20,000 in 2023. You went over the annual exclusion by $3,000 for the first time. So now you have to subtract that amount from your lifetime exemption : $12.92 million – $20,000 = $12.72 million. That’s how much you have left to give away in your lifetime before paying a gift tax.
Once it kicks in, the gift tax rate can climb to 40%, depending on how much of that money exceeds your lifetime exemption.
But, of course, the government may take a slice of your pie even after death. Because if you leave behind assets to your heirs when you pass away, you’re technically making gifts. So that too would reduce the lifetime gift and estate tax exemption that’s applicable the year that you die.
What Is the North Carolina Estate Tax?
North Carolina currently does not enforce an estate tax, often referred to as the “death tax.” But the federal government levies the estate tax on the portion of your estate that you pass on to your heirs if it’s valued above a certain limit. That limit is the applicable lifetime gift and estate tax exemption when you pass away.
Of course, the current lifetime exemption is very high compared to historic levels. Individuals effectively shield $12.92 million for 2023 from estate taxes, assuming they never breached an annual gift tax exclusion in their lifetime. And with careful estate planning guided by a financial advisor and attorney, married couples can protect up to twice as much.
However, the current lifetime exemption levels made possible by the Tax Cuts and Jobs Act are set to expire Dec. 31, 2025. Absent Congressional action, they likely would revert back to their pre-2017 levels of $5.49 million for individuals.
Nonetheless, you can take a few steps to protect the assets you pass on to loved ones from government hands.
North Carolina Estate Planning
As you can see, the government generally begins taking a cut of your estate once its value reaches a certain level. So in essence, you can protect what you intend to leave behind to others by giving it away while you’re alive. This move basically reduces the size of your estate and makes it harder for the government to claim a piece of it upon your death.
One way to do this is by taking advantage of the annual gift tax exclusion. Remember, it currently stands at $17,000. Plus, this exclusion applies per person. So you can give up to $17,000 to as many people as you want without worrying about gift taxes. For example, you can give $17,000 to your son, daughter and grandchildren each in a year without catching Uncle Sam’s attention.
But oftentimes, young people may not have the expertise to manage such large sums wisely. One way to get around this is by establishing a trust fund and naming your children as beneficiaries. There are several types of trusts out there with their own rules and legal boundaries.
But with the help of an attorney and the guidance of a qualified financial advisor, you can establish an irrevocable trust for your children’s future benefit.
Moreover, all the assets you transfer toward the irrevocable trust technically leave your ownership. Thus, they effectively reduce the size of your estate. These assets can include pretty much anything with value. We list some examples below:
- Savings accounts
- Certificates of deposit (CD)
- Mutual funds
- Investment portfolios
You can choose a financial advisor, investment professional or anyone else to be a trustee in charge of managing assets in the trust. Of course, state law governs specific provisions of an irrevocable trust, and these types of trusts may not be best for everyone. That’s why it’s always best to examine trust funds with the guidance of a professional financial advisor and tax professional.
What Gifts Are Nontaxable?
When you provide money or any other kind of property to certain individuals or institutions, the IRS won’t look at it as a taxable event. This means you can give as much as you want without catching the government’s attention. And it won’t reduce your lifetime gift and estate tax exemption. Below, we offer some examples.
Spouse: As long as your spouse is a U.S. citizen, you can transfer as much money or property as you want without triggering a gift tax. If your spouse is not a citizen, however, you have an annual limit before it starts to eat away at your lifetime exemption. For 2023, it’s $175,000.
Medical Expenses: If you pay a bill to cover qualified medical expenses on behalf of someone else, it won’t reduce your lifetime exemption. However, you need to send it directly to the care provider. To determine if a particular expense is eligible, you should seek a tax professional. We cover some general instances below:
- Diagnosis and treatment of disease
- Transportation generally required for medical care
- Medical insurance
Tuition: If you cover tuition on behalf of someone else such as your child, the IRS won’t consider it a taxable gift. However, you need to send the money directly to the educational institution. If you send it directly to the student, it’s a taxable gift. And if it exceeds the annual exclusion amount at the time, it will chip away at your lifetime exemption. Considering the price of tuition these days, that’s a mistake you don’t want to make. And remember, this rule applies to tuition only. Sending money to cover books, mandatory fees and other educational expenses doesn’t count. However, you can cover these with 529 college savings plans. These savings vehicles also come with an exclusive gift tax exemption.
Gift Tax Exemption for 529 Plans
When you contribute toward a 529 plan on behalf of a beneficiary such as your child, you’re technically making a gift. However, the IRS lets you take advantage of a particular perk exclusive to 529 plans. You can contribute up to $85,000 toward a 529 plan without reducing your lifetime gift and estate tax exemption, as long as you don’t contribute any more toward a 529 plan with the same beneficiary for the next five years.
Basically, the IRS lets you use five years worth of your annual exclusion in one shot. For 2023, that’s $17,000 multiplied by 5, or $85,000.
That’s how it works if you contribute $85,000 in one shot. Otherwise, it’s pro-rated. So if you contribute $34,000 ($17,000 x 2), you’ve used up two years of your annual exclusion. So you can’t contribute toward the plan for the next two years instead of five.
What You May Not Know About the Gift Tax
Keep in mind, however, that these limits can change from year to year. The lifetime gift and estate tax rose dramatically thanks to the Trump Tax Plan. However, these limits are set to expire at the end of 2025. Unless Congress moves to make these tax cuts permanent, the exemption may revert back to where it was before the new tax plan. That’s roughly $5.49 million for individuals.
North Carolina repealed its gift tax, but you may still owe gift taxes at the federal level. However, you have an annual gift tax exclusion of $17,000 for your 2023 returns. You can gift this amount to any number of persons without worrying about the IRS. If you go overboard, however, you’d need to report it on IRS Form 709. Once you do that, you begin to reduce your lifetime gift and estate tax exclusion. This is how much you can transfer before you owe an actual gift tax. The rate can be as high as 40%. But you can also make certain non-taxable gifts in any amount. You can also take steps to reduce your taxable estate such as creating trusts.
Tips on Reducing Gift Tax
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