Gifting has been a common practice throughout human history. It is an act of kindness and generosity that brings people closer. People offer gifts to friends, family, and organizations that align with their values all year round. However, it is important to remember that financial and asset gifts can also be construed as a transfer of wealth, which the IRS takes note of. The government imposes up to 40% gift tax on property transfers from one individual to another, whether in physical items or cash. If the gift exceeds a specified value, you may have to file gift tax returns and even pay additional taxes. Here’s what you need to know about gift taxes and how they can affect you.
What Is Gift Tax?
A federal gift tax is evaluated on property transfer or cash valued above a specified threshold. The government primarily imposes gift tax to prevent wealthy families from avoiding estate taxes by gifting their loved ones assets during their lifetime. The good news is that the threshold for gift taxes is so high that very few people actually pay these taxes.
As of 2023, the IRS allows you to give away up to $17,000 in property and money to as many people as you wish in a year. There is also an exception of $12.92 million in tax-free gifts over a person’s lifetime. If you exceed your annual exclusion, you must file Form 706 and report your gift to the IRS.
Who Pays the Gift Tax?
Generally, you do not need to worry about paying taxes on gifts you receive from your loved ones. The giver of the gift is the one who files a gift tax return and pays the gift tax. You can also make special arrangements when the gift recipient agrees to pay the taxes instead of the donor.
In most cases, it is clear when one is making a gift when they transfer valuable items from one person to another without getting any money in return. However, sometimes, someone may transfer a gift without thinking of it as a gift. For instance, gifting a gift to your child is a taxable exchange. Your spouse is the only individual you can give a gift to without any potential tax consequences, but there are other situations that are exempt from the gift tax. These scenarios include gifting to charitable or political organizations and paying medical or tuition expenses on somebody’s behalf.
How Can You Avoid Gift Taxes?
To avoid filing and paying gift taxes, you should be cautious not to unintentionally exceed the annual gift tax exclusion limit in one year. For instance, you might choose to pay your grandchildren’s college expenses by contributing $20,000 each to their college savings plans. Because you are contributing to a savings plan rather than paying directly for education expenses, you will have to file gift tax returns to report these gifts. In addition, if you decide to pay for your daughter or son’s wedding or foot their honeymoon bill and spend over $17,000, you are gifting them and will have to file a return on each gift. You can potentially avoid gift taxes by spreading your gifts or finding ways of paying directly for educational or medical expenses instead of gifting funds.
Gift taxes should not hinder you from giving gifts to your loved ones, but understanding the federal gift tax is crucial so you don’t end up on the wrong side of tax laws. Careful planning will also allow you to gift as much as possible without bearing a huge tax burden. Remember that gift tax regulations may be complicated, and working with a qualified tax specialist will help you navigate this process seamlessly.