There are few better feelings in life than giving the perfect gift to a loved one. And while gifting to family and friends certainly has its benefits, you could face some unintended financial consequences in the process.
The federal government imposes a gift tax of up to 40% on transfers of property from one person to another, whether it’s cash or a physical item. If your gift exceeds a certain value, you may have to file a gift tax return and pay the gift tax.
What Is the Gift Tax?
The gift tax is a tax that individuals must pay when they transfer a gift to another individual. The IRS defines a gift as a transfer of property from one individual to another, where the giver doesn’t receive payment for the full market value. The gift could be money, but it could also be other assets, such as stock or real estate.
The gift tax was initially enacted in 1924, temporarily repealed in 1926, and reenacted again in 1932. It was designed as a way to prevent wealthy families from avoiding estate taxes by transferring wealth to their children during their lifetime.
Who Pays the Gift Tax?
Generally, you don’t have to worry about paying any taxes on gifts you receive from loved ones. It’s the giver of a gift, not the receiver, that would file a gift tax return (Form 709) and potentially pay the gift tax.
Special arrangements can be made where the receiver of the gift may agree to pay the gift tax instead of the donor. If you are interested in this arrangement, the IRS recommends speaking with a tax professional for guidance.
In most cases, it’s pretty clear when a gift is being made—any time you transfer something of value from one person to another. But there are some situations where someone might be transferring a gift without truly thinking of it as a gift. For example, if you are giving a gift to your child, that is a taxable exchange. The only individual you can give a gift to without potential tax consequences is your spouse.
Something could also be considered a gift even if there is a partial payment made by the receiver. Suppose that a couple decided to sell their home to their adult child for a price of $250,000, but the fair market value of the home is actually $500,000. Even though their child paid them, the $250,000 difference between the purchase price and the market value is considered a gift.
The good news is that there are plenty of gifts that won’t be subject to the gift tax. Those gifts include:
- Tuition or medical expenses paid on someone else’s behalf
- Gifts to your spouse
- Gifts to a political organization
- Gifts to a charitable organization
Annual Exclusions and Lifetime Limits
Thanks to annual and lifetime exclusions, most individuals will never actually end up paying the gift tax, and many won’t have to file a gift tax return for the property they transfer to others.
The Annual Exclusion
For the tax years 2020 and 2021, the annual exclusion is $15,000. Individuals won’t have to file a gift tax return until they gift at least that much to another individual in one tax year. For example, if you gift someone $20,000, you will have to file a gift tax return for $5,000, which is the amount over the annual exclusion.
Keep in mind that the annual exclusion applies per individual, which means you can gift significantly more than $15,000 per year, so long as it’s given to multiple people or organizations. It also means that a married couple can give another individual up to $30,000 before they must file a gift tax return, since each spouse can technically gift up to $15,000.
The annual gift tax exclusion was indexed for inflation as part of the Tax Relief Act of 1997. To keep pace with the economy the amount can increase from year to year, but only in increments of $1,000. The exclusion has remained steady for several spans of years, increasing in 2002, 2006, 2009, 2013, and 2018.
The Lifetime Exclusion
Filing a gift tax return doesn’t mean you’ll actually end up paying gift taxes, as the IRS also has a lifetime exclusion for the total amount someone may gift throughout their lifetime before they pay gift taxes. The lifetime exclusion is $11.58 million for the 2020 tax year and $11.7 million for the 2021 tax year.
For example, if you gifted someone $20,000, you’d have to file a gift tax return for $5,000, the amount over the annual exclusion, but that $5,000 would then also count toward your lifetime exclusion, so if you haven’t used it up yet, you may not have to pay taxes on that money yet.
Large gifts transferred during your lifetime may also have tax implications after your death. Estates that exceed a certain amount are subject to the estate tax before they can be transferred to beneficiaries. But the gift tax exclusion and estate tax exclusion are interconnected.
The $11.7 million lifetime exclusion for tax year 2021 applies to both your gift and estate taxes. Any gifts you transfer during your lifetime that count against your lifetime exclusion also reduce the threshold for when your estate may be subject to estate taxes.
Let’s look at an example. Suppose that over your lifetime, you gift $3 million in excess of your annual exclusions. That money counts against your lifetime exclusion of $11.7 million. By the time you die in 2021, you have $8.7 million left of your lifetime exclusion, and any of your estate that exceeds that value would be subject to estate taxes.
The current lifetime exclusion is the result of an increase in the 2017 Tax Cut and Jobs Act. The increase will sunset in 2025, at which point the lifetime exclusion is set to be reduced to its pre-2018 level of $5.49 million.
How Much Is the Gift Tax for 2021?
If you eventually exhaust your lifetime exclusion and must pay gift taxes, the rate you’ll pay depends on the value of gifts subject to taxes. The current rates for tax years 2020 and 2021 range from 18% to 40%.
Here’s a table that illustrates the rate you’ll pay for certain gift amounts:
|Column A||Column B||Column C||Column D|
|Taxable amount over:||Taxable amount not over:||Tax on amount in column A:||Rate of tax on excess over amount in column A:|
- - - -
How the Gift Tax Is Calculated
The gift tax rate you’ll pay depends on the amount in excess of your annual exclusion that you gift in a given year. The simplest way to illustrate this is by using an example.
Suppose that Janet gives $20,000 to each of her three adult children each year. She’s already used up her lifetime exclusion, so everything above and beyond her annual exclusion is taxed.
The taxable portion of her gifts is $5,000 per recipient, or $15,000 total. The first $10,000 she gifts is taxed at a rate of 18%, for a total tax of $1,800. The next $5,000 is taxed at the next gift tax rate of 20%, amounting to $1,000. The total gift tax that Janet must pay for the year is $2,800.
You can think of the gift tax the same way you would income taxes, where each chunk of money is taxed at the rate for the bracket it falls into. The first $10,000 in taxable gifts is taxed at 18%, the next $10,000 is taxed at 20%, the next $20,000 is taxed at 22%, and so on.
- The gift tax is a tax on the transfer of valuable assets from one person to another.
- The gift tax rate ranges from 18% to 40%, depending on the value of the taxable gift.
- Gift givers may be subject to the gift tax anytime they transfer something for less than full market value to someone other than their spouse, a hospital or school on someone else’s behalf, a political organization, or a charitable organization.
- Individuals must only file a gift tax return after reaching their annual exclusion of $15,000 and must only pay gift taxes after reaching their lifetime exclusion of $11.7 million for the 2021 tax year.