How to Take Advantage of the Gift Tax Exclusion

The Annual Gift Tax Exclusion is important to understand if you wish to gift money to your heirs while you are still alive. In addition to allowing them to enjoy your generosity now, it reduces your estate for tax planning purposes.

Many of us spend much of our lives trying to accumulate wealth. Then, if you’ve been successful in doing that, you reach a point where you have to figure out how to give away some of that money without paying Uncle Sam for the privilege of doing so.

That’s when you want to learn about the IRS’s annual gift tax exclusion. Unlike many government programs with acronyms and convoluted language, the gift tax exclusion is exactly what it sounds like.

It’s a valuable tool that lets high-net-worth individuals transfer assets without incurring any tax liability for themselves or, in most cases, the recipient. It’s a great way to reduce your estate for tax planning purposes and, at the same time, allow family, friends, and loved ones to enjoy your generosity now while you’re still alive.

How Much Are We Talking About?

The gift tax exclusion for 2023 is $17,000 for each recipient. That’s up from $16,000 last year.

You can give this gift year after year and give it to as many people as you’d like each year. You can give $17,000 to each of your three children, your five grandchildren, your nephew, and even to the neighbor’s kid who mows your lawn. There is no limit on the number of people you can give to without worrying about the tax implications.

In the example above, that is ten gifts, or a total of $170,000 (10 x 17,000), with no tax obligations to be paid. And wait, there’s more! If you’re married, your spouse can gift another $17,000 to those same people, reducing your combined estate by $340,000. And you can do that again next year and every year after that.

Not only are these gifts excluded from taxation, but you don’t even have to report them to the IRS. However, if you exceed the $17,000 limit, the amount above that limit must be reported on IRS Form 709 and will count against your lifetime gift tax exemption.

Is the Gift Tax Exclusion the Same as the Gift Tax Exemption?

No, but they are connected. The gift tax exemption is a lifetime benefit: the amount you can transfer during your life or at your death without incurring any federal gift or estate tax.

For 2023, the gift and estate tax exemption is a whopping $12.92 million ($25.84 million for a married couple). Gifts that do not qualify for or exceed the annual exclusion described above will reduce the amount of your lifetime gift and estate tax exemption available at death.

It’s important to note that unless Congress acts to extend the current exemption level (which is indexed for inflation), the exemption will be cut approximately in half at the end of 2025 to about $6.2 million per individual.

That could make the next few years especially valuable in reducing your estate if it might be subject to a hefty tax in a few years. Federal estate tax rates range from 18% to 40%.

What Qualifies as a Gift?

The gift tax applies to any type of asset you give away or buy for someone else  – cash, stocks and bonds, real estate, a car, collectibles, etc.

Even if you sell something at less than its full value (your vacation home down the shore, for example) or make an interest-free loan, it may qualify as a gift, according to the IRS.

There are several important exceptions to this rule. These gifts are not taxable:

  • Gifts that are below the annual exclusion for the calendar year.
  • Tuition or medical expenses you pay for someone else.
  • Gifts to your spouse, which are unlimited.
  • Gifts to qualified charitable, religious, or political organizations.

It’s imperative to note that gifts for tuition or medical expenses must be paid directly to the school or medical facility. These gifts do not count against the $17,000 annual exclusion but do not make the mistake of giving the gift to the person instead of the institution.

In addition, you also can open a 529 college savings account for anyone and contribute up to the $17,000 per year limit per person. You can also front-load five years’ worth of gifts — $85,000 – at one time, as long as you don’t add any other gifts to that person during those five years.

Are There Any Drawbacks to Gifting?

While gifting is generally a win-win scenario, there are a few cautions.

First, you may not yet be ready to part with the wealth. Make sure that you’re not compromising your own financial security.

Some people may also be concerned about how their money will be used. You might end up financing a shiny, yellow Ferrari instead of a three-bedroom townhouse.

Other Notes About the Gift Tax Exclusion

  • The annual exemption applies to the year the gift is deposited. If you mail a gift check for this Christmas, but it does not get deposited until Jan. 2, 2024, it will count for next year, not this year.
  • While gifts are usually tax-free for recipients, they eventually may have to pay capital gains. If you gift stock, for instance, they assume your cost basis.
  • If you exceed the annual exclusion limit, the difference can be subtracted from your lifetime exemption, and no taxes are owed.
  • Some things you may not think about may qualify as a gift, such as a wedding or a family vacation for which you foot the bill.
  • If you want to gift money to a young person but don’t want them to have access to the money now, you can set up an irrevocable trust.
  • 32 states do not impose an estate tax. 18 states impose an estate tax or inheritance tax on wealth transfers.
  • These can be complex rules, so it’s advisable to check with your wealth advisor to ensure you stay within the guidelines when you give large gifts.

You know Ben Franklin’s famous saying: “Nothing is certain except death and taxes.”  Well, we don’t know how you can cheat death, but you may be able to avoid hefty estate taxes if you generously start to give away large chunks of your wealth before death comes calling.

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