Gift Tax Definition

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Gift Tax Definition

What Is a Gift Tax?

A gift tax is a federal tax paid by someone who transmits something valuable to another person without obtaining anything of like worth in return. Gifts may be anything of great value, such as huge quantities of money or real estate, and the tax can be applied even if the individual contributing had no intention of making the donation as a gift.

The Internal Revenue Service (IRS) establishes restrictions on how much you may give before filing a tax return and being taxed. Sums in excess of the yearly criteria must be reported and count against the lifetime gift tax exemption limit. When this large allowance is depleted, the gift tax becomes due.

Key Takeaways

  • The gift tax is a federal tax imposed on a taxpayer who transfers money or property to another person.
  • Depending on the quantity of the present, the gift tax varies from 18% to 40%.
  • The IRS provides a lifetime tax exemption on gifts that is increased annually to keep up with inflation.
  • Donations to U.S. citizens’ spouses, to political organizations for use by the organization, and for medical and tuition-related expenditures, as well as gifts worth less than the annual exclusion amount, are all exempt.
  • Gift splitting and gifts made in trust are two methods for avoiding the gift tax.

How a Gift Tax Works

The federal gift tax was enacted to prohibit people from avoiding income taxes by donating money or valuable objects to others. The gift tax is imposed to avoid excessive hardship and to compel donors and recipients to pay their tax obligations. Donors must complete the federal gift tax return (Form 709) and submit it with their yearly tax returns by April 15 of the year after the donation.

Gift tax rates vary depending on the quantity of the taxable gift and may range from 18% to 40%. The tax is only levied on yearly donations over a particular sum, with everything below that amount exempt. For 2021, the yearly exclusion is $15,000, and for 2022, it is $16,000. Because the restrictions are per recipient, you might give many gifts of up to $15,000/$16,000 to different persons without incurring the gift tax.

If you donate a gift that exceeds the annual exclusion limit but is less than the lifetime maximum, you must declare it but are not required to pay tax on it.

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The lifetime exclusion is the maximum amount you may contribute in your lifetime. This exclusion is $11.7 million in 2021 and $12.06 million in 2022, adjusted for inflation each year. Before the gift tax is levied, the donor may give up to this amount. However, yearly restrictions continue to apply, which implies that the lifetime exemption applies to sums in excess of the annual exclusions.

Special Considerations

Form 709 offers methods for calculating the amount of gift tax owing. However, submitting Form 709 does not guarantee that you will pay the gift tax.

If you provide a gift that exceeds the annual exclusion level ($15,000 in 2021 and $16,000 in 2022) but is less than the lifetime exclusion maximum ($11.7 million in 2021 and $12.06 million in 2022), you will not be subject to the gift tax—but you must still declare the gift.

There are also other exemptions from the gift tax. The following products are normally exempt from gift tax:

  • Gifts for the donor’s wife. If the spouse is a US citizen, an unlimited sum may be given tax-free. If the spouse is not a citizen of the United States, tax-free gifts are restricted to an annual adjusted value of $159,000 in 2021 and $164,000 in 2022.
  • Donations to a political group for its use
  • Payments provided by a donor to a person or institution, such as a college, doctor, or hospital, for medical and educational expenditures
  • Contributions to a charity organization
  • Gifts worth less than the yearly gift tax exclusion rate for that year

Gift Tax Strategies

There are ways to avoid or minimize the gift tax. These are some examples:

Gift splitting

Marriage helps you to double your talents. Keep in mind that the yearly exclusion limits the amount of gift that a person may provide to a recipient. That implies that, even if they file a combined tax return, couples may each contribute $15,000 to the same recipient in 2021 or $16,000 in 2022, essentially increasing the gift to $30,000/$32,000 in a year without triggering the gift tax.

This practice, known as gift splitting, allows rich couples to make significant yearly presents to their children, grandkids, and others. This present may be made in addition to, instance, tuition paid directly to a grandchild’s school or college, which is excluded from the gift tax entirely.

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Gift in trust

Donors may make tax-free donations in excess of the yearly exclusion by forming a specific kind of trust—the Crummey trust is the most common arrangement—to collect and disburse the cash.

The gift tax exclusion does not normally apply to funds distributed through trusts. A Crummey trust, on the other hand, permits the beneficiary to take the assets within a specified time frame, such as 90 days or six months. This provides the beneficiary with what the IRS refers to as a current interest in the trust, and this kind of distribution might qualify as a nontaxable gift. Of course, the receiver may only withdraw the amount equivalent to the trust’s gift.

Under some 529 college savings plans, you may give more than the yearly exclusion without reducing your lifetime gift tax exemption. In these circumstances, you declare the one substantial gift on your tax return as being spread over five years and submit the form each year. The sole restriction is that you cannot make any further donations to the same recipient during this time. If you do, your lifetime exclusion will be imposed.

Examples of the Gift Tax

Here are a couple of examples of how the gift tax works.

Assume Taxpayer A contributed $100,000 to five people in 2021—$20,000 to each. Because the yearly exclusion limit is $15,000 per person, the entire amount provided is not excluded, reducing the lifetime exemption amount by $25,000 So, after making these donations, Taxpayer A has $11.675 million of the exemption available to contribute before having to pay gift taxes.

Here’s another one. A grandma who wishes to support her granddaughter’s education paid $20,000 for a year’s tuition in 2021. She also donated the young lady $15,000 for books, materials, and equipment that same year. Neither contribution is reportable for gift tax purposes—the tuition is completely exempt, and the $15,000 is the yearly exclusion limit.

If Grandma handed the future physician $30,000 and the young lady had already paid for her education, the grandmother would have made a reportable (but non-taxable) gift of $15,000 ($30,000 minus the yearly exclusion of $15,000), reducing her $11.7 million lifetime exclusion by $15,000.

The Bottom Line

The gift tax is a government levy that applies when you donate an amount of money or assets, either physical or intangible, to another person or people without charge. It is levied on the giver, not the recipient.

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The gift tax, on the other hand, has been designed in such a manner that relatively few individuals wind up paying it. A variety of gifts are excluded, including anything given to a spouse. Furthermore, you may contribute an eight-figure sum during your lifetime before the gift tax kicks in—and even then, it only applies to the amount beyond that level.

How Much Is the Gift Tax?

The gift tax is levied on a sliding basis based on the value of the gift. It only applies to donations that exceed a particular level set by the IRS. After assessing a fixed sum, extra tax is charged at rates ranging from 18% to 40%.

How Much Can I Gift Someone Tax Free?

You may offer someone up to $15,000 for the fiscal year 2021 and $16,000 for the fiscal year 2022. Anything over those sums will deplete your lifetime gift allowance ($11.7 million in 2021 and $12.06 million in 2022), which would trigger the gift tax if spent.

Does the Receiver of a Gift Pay Tax?

Gift tax is typically not levied on the person who receives the gift. However, the receiver has the option to do so, particularly if the sum would exceed the donor’s lifetime gift tax exclusion.

How Much Can I Gift My Child?

You may present the same amount to your kid or grandchild that you can gift to other relatives or friends without paying the gift tax, namely:

  • Each grantee will get $15,000 in 2021 and $16,000 in 2022.
  • Over your lifetime, you will earn $11.7 million in 2021 and $12.06 million in 2022.

The IRS regularly adjusts these maximums for inflation.

Because the thresholds of $15,000 and $16,000 apply to a single donor, a married couple may both contribute that amount to the same kid, for a total yearly donation of $30,000 and $32,000, respectively.

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