According to the IRS, when someone gives another person money and does not receive full consideration in return, they are making a gift. Full consideration is the fair amount of compensation that would otherwise be paid if the parties were not related. Gifts are considered income to the recipient and are subject to taxation. A few exceptions include tuition or medical expenses one pays on behalf of another, gifts to a spouse, and gifts to political organizations. The burden of tax, however, rests on the donor, not recipient. There is a gift tax exclusion, which allows individuals to make tax-free annual payments to as many people as desired. In 2023, the exclusion amount is $17,000 for single taxpayers and $34,000 for those married filing joint. In theory, this can be hundreds of gifts each worth $17,000, or $34,000 all free of tax. This large exclusion amount enables gifts to be free of tax in most cases. The amount of the exclusion adjusts with inflation, as it has come up from $16,000 in 2022 and the $15,000 limit it held from 2018 through 2021. The lifetime gift exemption is not to be confused with the Generation Skipping Tax (GST). The GST is a tax that is imposed on transfers that skip generations, such as gifts from grandparents to grandchildren or great grandchildren. The purpose of the GST is to close the loophole that previously allowed individuals who surpassed their gift exemption amount to avoid incurring federal gift taxes.
Whenever a gift is made that exceeds the gift tax exclusion, one must consider the estate tax exemption. The estate tax exemption is the amount of one’s estate that is free from being taxed over the course of their lifetime. For 2023, the estate tax exemption is worth $12.92 million but, like the gift tax exemption, rises with inflation. Also like the gift tax exemption, the estate tax exemption amount doubles to $25.84 million for those who are married filed joint. Anyone who makes a gift that exceeds the gift exclusion amount reduces their estate tax exemption by that same amount. Only once a person gifts enough money to surpass the annual gift exclusion and drain their entire $12.92 million estate exemption will gift taxes have to be paid.
The reason for a federal gift tax is not to prevent people from giving gifts or financial support to friends, family, and others. In fact, the majority of people will never pay the gift tax. Rather, the gift tax prevents the loss of tax revenue that would occur if extremely high net-worth individuals were to simply give their money away before they die, leaving nothing left to be taxed on their estate. By limiting the amount of money that can be passed down to one person annually, the gift tax works hand-in-hand with the estate tax to prevent massive amounts of money from be handed down tax free from generation to generation. The gift tax is not something most people should worry about as it targets just a select few.
If you have questions about whether the gift tax applies to you, the professionals at ADKF can help.