The Lifetime Exemption for Federal Gift Taxes
The exemption is very generous, at least through 2025
The lifetime exemption for federal gift taxes is a dollar amount you can give away without paying the tax—and yes, it's the giver, not the recipient, who must pay it. The Internal Revenue Code also provides for an annual exclusion, and some gifts are exempt from taxation, so they don't count against either the exemption or the exclusion.
The exemption has increased significantly over the years, while the gift tax rate has decreased. As of 2018, applicable for tax years 2019 and 2020, the top tax rate is 40%, down from 55% 2001.
The Effect of Legislation on the Gift Tax
The gift tax was based on the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act (TRUIRJCA) from 2010 through 2012. The TRUIRJCA was signed into law by President Barack Obama on Dec. 17, 2010. It was only supposed to be in effect for two years, but President Obama then signed the American Taxpayer Relief Act, known as ATRA, into law on Jan. 2, 2013.
ATRA made certain TRUIRJCA provisions permanent. These provisions affected both the federal estate tax and the gift tax.
Then came the Tax Cuts and Jobs Act (TCJA), signed by President Donald Trump on Dec. 22, 2017. The TCJA went into effect in January 2018 and it made a significant change to the estate and gift tax exemption, virtually doubling it.
The federal estate and gift tax exemption is indexed for inflation. The two taxes share the same exemption, and it's adjusted periodically to keep pace with the economy.
Federal Gift Tax Lifetime Exemptions and Rates 2000-2020
|Year||Gift Tax Exemption||Top Gift Tax Rate|
How the Annual Gift Tax Exclusion Works
The annual exclusion is $15,000 for tax years 2019 and 2020. You can give this much money or property to any one individual per year without incurring a gift tax. If you want to give gifts to two people, they can total $30,000. You can give $45,000 to three people, and so on.
If you give your child $20,000 in one calendar year for a down payment on a house, you have a choice to make. You can either pay the gift tax on the additional $5,000 over the annual exclusion in the current year, or you can apply your lifetime exemption to the $5,000. That's worth $11.4 million for tax year 2019 and $11.58 million for tax year 2020.
That covers a lot of giving, but there's a catch.
The Unified Credit
The federal gift tax and estate tax are tied together by the unified credit. You can use the unified credit to shelter your estate from taxation when you die, or you can use it to defray the tax burden of giving more than the annual gift tax exclusion to any individual in a given year.
Here's how it works. If you decide not to pay the gift tax on that extra $5,000 you gave away over the annual exclusion, you must file a gift tax return anyway via Form 709. You would indicate on the return that you want to apply the lifetime exemption provided by the unified credit. The $5,000 is then deducted from your lifetime exemption. You'll have $5,000 less of the unified credit to protect your estate from estate taxation when you die. In the future, if you ever file tax Form 709 again, you'll need to indicate that you've filed it in the past, and include information about gifts made in that prior period on Schedule B.
Of course, $5,000 would hardly be missed from the $11.4 million exemption that's available in 2019, or the $11.58 million exemption in 2020, so if you have nowhere near $11 million-plus in assets, this may be a good deal. But if you expect to have considerable wealth by the time you die—enough that the $11 million-plus unified credit might not shelter your entire estate—using it to cover gifts in excess of the annual inclusion instead can cost your estate money that would otherwise go to your heirs. The top federal estate tax rate is also 40%.
Other Exemptions: Education
Some other exemptions and provisions exist for special gifts. For example, contributions to a 529 college savings plan can be spread out over five years—the entire amount doesn't count as a gift in the year you make it.
You can give a prospective student $75,000 and claim the annual exclusion of $15,000 each year for five years so you won't have to pay a gift tax on that amount, and you don't have to deplete your lifetime exemption. But you can't give that student any other gifts during this five-year period without dipping into your lifetime exemption.
You can also pay a student's qualifying tuition expenses tax free in any amount without incurring the gift tax, provided that you give the money directly to the educational institution.
Other Tax-Free Gifts
Uncle Sam actually does encourage generosity—he just doesn't want you to deplete your estate during your lifetime to avoid owing an estate tax when you die. You can give as much as you like to qualified charities that are approved by the IRS without incurring a gift tax.
And you can pay someone else's medical bills up to any amount as long as you pay the care providers and institutions directly, like the exemption for tuition, the money can't pass through the beneficiary's hands.
And If You're Married...
Marriage effectively doubles your annual exclusion because you can "split' your gifts with your spouse. Remember that $20,000 you gifted your child that went $5,000 over the 2019 and 2020 annual exclusion of $15,000? Only $10,000 will count against your annual exclusion if you're married and you and your spouse each give your daughter $10,000. Instead of going $5,000 over your exclusion, you and your spouse each have $5,000 of your respective annual exclusions left.
You can also give to your spouse to your heart's content without incurring a gift tax, provided they're a U.S. citizen.
The Bottom Line
The lifetime gift tax exemption lets the average American give away a lot of money and property tax free. If you expect that your estate will be more sizable, consider consulting a CPA or a tax attorney before deciding to dip into it.
This can be especially important because the lifetime exemption might or might not remain at the $11 million-plus mark. The TCJA is set to expire at the end of 2025. The exemption may then decrease in 2026 unless Congress acts to keep the TCJA's estate and gift tax provisions in place going forward.
IRS. "Frequently Asked Questions on Gift Taxes: Who Pays the Gift Tax?" Accessed Jan. 15, 2020.
IRS. "What's New - Estate and Gift Tax." Accessed Jan. 15, 2020.
Congress.gov. "H.R.4853 - Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010." Accessed Jan. 15, 2020.
Congress.gov. "H.R.8 - American Taxpayer Relief Act of 2012." Accessed Jan. 15, 2020.
Congress.gov. "Tax Cuts and Jobs Act." Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709." Accessed Jan. 15, 2020.
IRS. "Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return." Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709," Page 7. Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709," Page 2. Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709," Page 12. Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709," Page 3. Accessed Jan. 15, 2020.
IRS. "Instructions for Form 709," Page 6. Accessed Jan. 15, 2020.