New Jersey doesn’t have a gift tax. However, you may still owe a federal gift tax if the value of the gifts you provide exceed a certain amount. Following the passing of the Tax Cuts and Jobs Act, the federal gift tax exclusion rose to $15,000 for 2021 and $16,000 for 2022. So you can give someone $15,000 or $16,000 worth of cash, assets or property (depending on which year it is) annually without worrying about a gift tax. You would have to report it if you breach that threshold. But you won’t owe anything out of pocket until you exceed your lifetime exclusion limit. This article will cover everything you need to know about the gift tax as well as steps you can take to avoid or minimize your tax payment obligations. We can also help you find a financial advisor to assist you with your estate planning.
What Is the Annual Gift Tax Exclusion?
For tax years 2019, 2020 and 2021, the annual gift tax exclusion was $15,000 for any individual without setting off any gift tax red flags. That climbed to $16,000 for the 2022 tax year. The exclusion applies per person each year.
If you give more in value to an individual than your annual exclusion, however, you may just need to file some extra paperwork with the IRS. In this case, you’d be required to report the gift on IRS Form 709. It’s officially known as the United States Gift (and Generation-Skipping Transfer) Tax Return. This form is due by April 15 following the date you made the gift. However, you may request an extension up until Oct. 15.
But keep in mind that just because you’re required to report the gift to the IRS, it doesn’t mean you will pay an out-of-pocket tax. In order to trigger a bill, you’d need to breach the lifetime gift and estate tax exemption, which is $11.7 million for 2021 ($23.4 million for married couples) and $12.06 million for 2022 ($24.12 million for couples).
When Do I Owe the Gift Tax?
If you breach your lifetime gift and estate tax exemption, you’d owe gift tax. Unfortunately, the tax rate on money you’ve given can rise quite high, up to 40%. However, the government would only apply this to the portion that goes above the exemption. So if the exemption was $12.06 million, as it is for 2022, and you gave away $12.4 million, you’d be taxed on the difference of $340,000.
Still, there are certain steps you can take to protect your money and still remain courteous.
Reducing the Size of Your Estate
If you leave behind portions of your estate to heirs when you pass, you’re technically making a gift. The IRS can tax a portion of its value before it gets transferred to the designated heirs. This is one of the reasons why the estate tax is often referred to as the “death tax.”
The key point to understand here is that the gift tax and the estate tax are essentially tallied from the same bucket. So if you eat into your federal gift tax exemption, you have less to leave behind tax-free in your estate. But you only begin to eat away at your exemption if you gift more than the applicable annual limit to a specific individual in a year. You can give away cash or property valued at this amount to as many people as you want without reducing your lifetime exemption. Moreover, this move effectively reduces your taxable estate.
But if you do end up owing an inheritance tax, you’d only pay for it at the federal level. The state legislature voted to repeal the New Jersey estate tax effective Jan. 1, 2018.
But if you’re affluent, you still have plenty of options to protect what you leave behind to your heirs. For example, you can establish a trust fund with the help of an attorney. There are several types of trusts out there with their own rules and legal implications. But one common option is an irrevocable trust.
With this kind of trust, you can designate a beneficiary such as a child. The assets get transferred when you pass away. But while you’re alive, the assets you transfer into the trust cease being your property. In essence, they lower your taxable estate. Plus, you can designate a trustee such as a financial professional to manage the assets in the trust.
These can include basically anything with value, including savings and retirement accounts, investment portfolios and individual securities.
What Gifts Don’t Get Taxed?
Depending on where your gifted money or assets go, you may not owe any gift tax at all regardless of the value those gifts carry. We’ll explore a few examples below:
Spouse: You can give as much as you want to your husband or wife without incurring a gift tax as long as your spouse is a U.S. citizen. If you’re married to a foreigner, you have up an annual limit before it applies to your lifetime exemption. For 2019, it’s $154,000; for 2020 it’s $157,000; for 2021, it’s $159,000; and for 2022 it’s $164,000.
Medical Expenses: When you send money to an institution such as a hospital to cover eligible medical expenses, you won’t have to pay a gift tax on that money, regardless of the amount. Eligible expenses can be elusive in the eyes of the IRS, however. You should seek a qualified accountant in your area to discuss making these types of payments.
Charity: Donating to a registered nonprofit organization is not a taxable event in most cases. But the lines can blur here, too. Seek a financial advisor and tax professional for specific rules around donating to charities.
Tuition: If you send money directly to an educational institution to cover tuition on behalf of someone else, the IRS doesn’t consider it taxable. However, keep in mind that you must send it right to the school. If you provide it to the student to cover it, you may reduce your gift tax exemption. However, a special rule applies when investing in 529 plans to save for someone else’s college expenses.
529 Plans and Gift Taxes
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 2022, that’s $16,000 multiplied by 5, or $80,000. In 2021, the annual exclusion was $15,000, or $75,000 in five years.
If you choose to contribute less than five years, it’s pro-rated. So if you contribute $32,000 ($16,000 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 $80,000, you would reduce your lifetime exemption because you gave an individual more than $16,000 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 $16,000 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.
Even though New Jersey doesn’t impose a gift tax, you may owe a federal gift tax. But you won’t owe an actual gift tax until you’ve breached your lifetime gift and estate tax exemption. With careful estate planning, a married couple can shield their gifts from taxation. But this rate is set to expire in 2026 unless Congress makes it permanent. If it doesn’t, then it will revert back to its pre-2017 level of roughly $5.49 million. Nonetheless, you have several options to steer clear of gift and estate taxes such as taking advantage of your annual exclusions and carefully establishing trusts.
Tips on Minimizing Gift and Estate Taxes
- The government may impose a heavy tax on the estate of a wealthy family before it’s passed on to the proper heirs. However, you can take several steps to avoid or minimize the estate tax. Speak to a financial advisor and a legal professional who specializes in estate planning. He or she can guide you through building the right trusts and taking other precautions.
- Tax planning is every bit as important as estate planning; and both are best done with the guidance and insight of a financial advisor. 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.
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