If you’re looking to leave your estate to heirs either while you’re still around or even if you want to wait until you pass, you’re going to want to familiarise yourself with gift tax.
Very few people will ever have to pay gift tax but if your estate is worth over $10 million you’ll need to be aware of the rules and provisions that will allow you to minimize or eliminate your gift tax liability.
What is Gift Tax?
The gift tax is a tax on the transfer of cash, stock, property or other assets from one individual to another. The IRS states that, as a general rule, any gift is a taxable gift. Thankfully there are a few major exclusions that keep the tax from affecting most gifts.
The first is the annual exclusion limit which allows a certain amount of tax free gifting every calendar year. Others include tuition or medical expenses paid for someone else, gifts to your spouse and gifts to a political organization for its use. Additionally, gifts to qualifying charities are considered charitable donations and are deductible from the value of the gifts made.
Who Pays Gift Tax?
Most people will never have to worry about paying gift tax but if a gift is subject to gift tax, the donor is generally responsible for paying it. Under special circumstances arrangements can be made for the donee to pay the tax instead.
It’s important to note that even in cases where a giver receives compensation from a transaction it can still be liable for gift tax if the sale price is significantly less than current fair market value of the asset. This is most frequently seen in the sale of property or stock between family members.
How Much Can You Gift Tax Free?
For 2020 and 2021, the annual exclusion limit per donor is $15,000 to each donee. So if a married couple wanted to give their two children cash gifts they could give them $30,000 each in a calendar year and not be liable for gift tax.
If you give more than $15,000 in cash or assets in a year to any one person, you need to file a gift tax return but you still may not be liable for gift tax. Say that same couple wanted to give their children cars costing $40,000 each. They’d have to file a gift tax return but they can designate the extra $20,000 to count toward next year’s annual exemption and not owe gift tax in the current year.
Gift givers can spread one-time gifts across up to five years’ worth of gift tax returns to preserve their lifetime gift exclusion.
What is The Lifetime Gift Tax Exemption?
If that wasn’t enough, the IRS actually has another provision that further minimizes most people’s chances of ever paying a gift tax, the lifetime gift tax exemption. This exemption applies only to amounts exceeding annual exclusions. In 2021 the exemption is $11.7 million per person for their lifetime.
You might notice that the lifetime gift tax exemption is the same as the threshold for filing an estate tax return. Together you may see them referred to as the unified tax credit or unified credit.
Just like with the gift tax, to be subject to estate tax the gross estate of the deceased plus adjusted taxable gifts and exemptions must be valued at more than the estate tax filing threshold for the year of their death. Meaning you can save your lifetime gift tax exemption to minimize or eliminate your estate tax liability when you pass.
For example, if you never touch your lifetime gift tax exemption and want to gift your estate worth $11 million you won’t be subject to the estate tax. Alternatively if you want to gift $1 Million every year for 10 years and give the last million after you die you’re in a similar boat. The only difference is that by passing on your assets while you’re still alive, $15,000 per year falls under the annual exemption.
How Much is Gift Tax For 2020 - 2021?
If you do have to pay gift tax, rates range from 18% to 40% and are marginal, just like your federal income tax payments.
$10,000 or less
$10,001 to $20,000
$20,001 to $40,000
$40,001 to $60,000
$60,001 to $80,000
$80,001 to $100,000
$100,001 to $150,000
$150,001 to $250,000
$250,001 to $500,000
$500,001 to $750,000
$750,001 to $1 million
More than $1 million
And again, very few people will ever pay gift tax, even if they file a gift tax return. On average only 1.1% of gift tax returns filed are actually taxable. And from 2010 to 2016, 95% of gift tax payers were those giving more than $1 million in gifts in a given year.
How To Avoid Paying The Gift Tax
The best way to avoid paying gift tax is to gift your estate up to the annual exclusion limit per donee for you and your spouse for as many years as possible until your estate is with the lifetime gift tax exemption. The lifetime gift tax exemption typically increases every year so even if your estate is worth more than $11.7 million currently, you may not be ruled out of the exemption if you pass in several years when the limit is higher.
Gifts between spouses are unlimited and generally don’t trigger a gift tax return so that’s another thing to consider. In the end, if you don’t see yourself offloading enough to escape gift tax but would rather that money go elsewhere, gifts to nonprofits are charitable donations, not gifts.
Most People Don’t Have to Worry About Gift Tax
Thanks to the annual and lifetime exemptions as well as provisions allowing you to preserve your lifetime limit, it’s very rare for anyone to be required to pay gift tax. Those with a net worth above $10 million may want to be aware of gift tax rules but you can easily legally avoid it if your annual gifts are under $1 million each year.