Most people understand that they need to pay taxes to the government, but many are unaware of the IRS gift tax. The IRS imposes a gift tax on certain transfers of property that involve no exchange of value, such as giving money or assets to someone without receiving anything in return. Understanding the gift tax can help you avoid unnecessary tax penalties. In this blog, we’ll look at the IRS gift tax, what it entails, and how it can affect your gift-giving activities.
Basics of Gift Tax
The primary IRS gift tax rules are straightforward: if you give someone money or property worth more than the annual gift tax exclusion, you must file a gift tax return and pay tax on the excess amount. The annual gift tax exclusion is currently $17,000, meaning you can give up to $17,000 to an individual in one year without incurring the gift tax. The lifetime federal estate and gift tax exemption, on the other hand, is $12.92 million.
The lifetime exemption for federal estate and gift tax, combined, is $12.92 million. This means that during your lifetime, you can give away up to $12.92 million without paying any federal gift tax. However, if you give away more than this amount, you’ll have to pay a tax on the excess. Also, as with gift taxes, if you are married, your spouse is entitled to their own $12.92 million lifetime exemption.
To further clarify, any transfer that exceeds either the annual gift tax exclusion ($17,000) or the lifetime gift tax exclusion ($12.92 million) is subject to taxation. The maximum tax rate imposed on these excess amounts is 40%. For example, if you give a gift of $18,000 to an individual within a year, you would have to pay tax on the $1,000 that exceeds the annual exclusion. Similarly, if your lifetime gifts exceed the $12.92 million limit, the surplus amount will be taxed at a rate of up to 40%.
Widows and Widowers Exemption Benefits
It’s important to note that there are special provisions for widows and widowers. If your spouse passes away, you may claim unused portions of their lifetime gift tax exclusion. This allows you to increase your exemption, potentially up to a maximum of $10.68 million. This provision, known as portability, offers significant tax benefits and can play a vital role in estate planning for surviving spouses.
How to Avoid Gift Tax
One way to avoid gift tax is by distributing gifts in small amounts to each of your recipients, up to the annual exclusion amount. This helps to ensure that your gifts don’t exceed the annual exclusion amount and, therefore, do not get subject to the gift tax. Alternatively, you could set up a trust to receive and distribute gifts over time, which could help you avoid exceeding the annual exclusion amount.
When to File a Gift Tax Return
If you’ve given gifts worth more than $17,000 to any single individual in one year, you need to file a gift tax return. You should also file a return if you’ve split a gift with your spouse, which means that you and your spouse combined have given more than $17,000 to a single individual. The gift tax return is due on April 15th of the year following the year in which you made the taxable gift.
What Gifts Are Not Taxable?
Finally, it’s important to note that not all gifts are taxable by the IRS. Certain types of gifts are exempt from taxation, including:
- Donations made to charities that are approved by the IRS.
- Gifts made to your spouse, provided they are a U.S. citizen.
- Payments made directly to an institution to cover tuition costs, provided the gift only covers tuition expenses and not additional fees such as room and board, books, or supplies.
- Donations made to political organizations.
- Gifts to cover medical expenses, provided these are paid directly to the medical facility, such as making a payment directly to a hospital to cover a bill.
These gifts do not need to be reported to the IRS for gift tax purposes. Furthermore, any gifts made to a qualifying charity can be deducted from the total amount you’ve gifted, further reducing your tax liability.
Enjoy a Hassle-Free Gift-Giving Season With KDK Accountancy
Understanding the IRS gift tax rules can save you a lot of money and potential problems. While the gift tax can be complicated, and the amount can change over the years, familiarizing yourself with the annual exclusion and lifetime exemption can help you navigate this tricky tax area. However, to ensure accuracy and avoid mistakes, seeking professional advice from a financial planner or tax expert is always recommended.
At KDK Accountancy, we specialize in accounting and tax preparation services in Orlando, FL. Our experienced team is ready to assist you with any inquiries or concerns. Contact us today at (407) 759-5363 to schedule a FREE consultation and discover how we can help you optimize your financial planning.