How to Avoid the Gift Tax: 5 Tips
You may have heard that there’s a gift tax, and you probably assume that means you can only give someone up to a certain amount before paying taxes on the cash. Maybe you’ve heard the threshold is $15,000 per person. But what if you want to give someone more than that? Do you just have to stay under the cap? Do you need to document it in some particular way?
In this article, we will familiarize ourselves with this particular type of tax and how you may be able to avoid gift tax.
What Is the Gift Tax?
A gift tax is applied when a person gives someone else a gift of significant value, such as money or property. In other words, if the gift amount exceeds the annual limit, you will be required to complete IRS forms and potentially pay taxes.
Contrary to popular belief, gifts are taxable. However, this does not mean you cannot give gifts at all – there are just some rules about how, when, and what kind of gifts qualify for exemption from taxes.
How Much Money Can a Person Receive as a Gift Without Being Taxed?
The gift amount limit is currently set at $16,000 in 2022. If the gifted assets, such as a car or real estate amount to more than $16,000 in one year, you are liable for gift tax. The individual giving the gift will need to complete the IRS Form 709 and file it to disclose the gift to the IRS. However, this doesn’t necessarily mean that you have to pay the tax. Why? Because of lifetime gift tax exemption.
Apart from the annual $16,000 exclusion, which renews every year, U.S. taxpayers also have a lifetime exclusion amount. The lifetime exclusion amount is $12.06 million per person and per recipient.
Keep in mind the annual gift limit is applied per recipient. Essentially, you have a $16,000 gift limit for each person you give to. For example, you can give up to $16,000 to each of your friends or family members. In addition, gift tax does not apply when giving to spouses or dependents, and gifts to nonprofits are treated as charitable donations that follow separate tax legislation.
For example, if you give a $30,000 gift to a friend:
- You would use your $16,000 annual exclusion entirely.
- Your lifetime exclusion would be reduced by $14,000.
- You would owe no taxes, and your lifetime exemption would decrease to $12,046,000.
However, if you exceed your yearly and lifetime exemption limits, you must pay the gift tax. The tax rates range from 18% to 40%, depending on the value of the gift. It’s a progressive tax, meaning the tax rate increases as the gift value increases. For example, the gift tax on a $17,000 gift may be 18%, but a $200,000 gift will have a higher tax rate.
5 Tips to Avoid Paying Tax on Gifts
When giving a gift to someone, you're likely wondering why you are being taxed for your generosity. Thankfully, most people do not need to worry about paying a gift tax. If you are one of the rare few to whom the tax applies, then you still may be able to avoid paying taxes without evading them.
Respect the Gift Amount Limit
The easiest way to avoid the gift tax is to stay within the annual limits. The IRS has currently set the gift amount limit at $16,000, though they usually increase the amount every year because of inflation.
Everyone is allowed to spend a maximum of $16,000 on a gift per recipient without any tax obligations. The amount limit doesn’t only apply to gifts in cash but also extends to assets, securities, or property. However, some exceptions let you go over the federal gift tax limit, such as when the gift includes covering one’s education or medical expenses.
Provide a Gift Directly for Education Expenses
If you want to pay someone’s tuition as a gift, you will typically be exempt from paying the gift tax. However, you must make the payment directly to the institution and not the recipient. This way, you can spend more than the annual limit and still be exempt from the gift tax.
Please note that only payments for tuition can be considered for tax exemption. If you want to pay for the student’s books or housing expenses, you will still be liable for a gift tax if the amount exceeds the limit. The recipient must be a part-time or a full-time student in any educational institution with a curriculum, faculty, and student body.
Provide a Gift Directly for Medical Expenses
Similar to tuition bills, you can avoid the gift tax when covering someone’s medical expenses. Again, the exemption is possible only if you pay directly to the hospital or insurance provider.
Additionally, the exclusion for covering medical expenses applies only to deductible medical costs. So, for example, you can pay for the prescription drugs, provider’s fees, or medical insurance but not for someone’s gym subscription or other health-related expenses.
You can also set up regular payments for medical services for someone and be exempt from gift tax if you pay directly to the institution. For example, if you want to pay for your grandparent’s stay at a nursing home, you can open a bank account and make monthly payments to the nursing home’s account without worrying about going over your annual gift limit.
Take Advantage of Marriage in Giving Gifts
Keep in mind that the annual tax exemption limit for gifts applies to each person separately, even to married couples. This means that as a married couple, you can give up to $32,000 without paying gift tax.
For example, let's say you and your spouse are invited to your friends' wedding. You can give up to $16,000 to one of the newlyweds and another $16,000 to the other. Similarly, your spouse can also give up the same amount to both partners. So both of you together can spend up to $64,000 for the wedding gift without exceeding the gift tax limit.
Structure the Gift Over Several Years
Another possibility to avoid gift tax is structuring the gift over time. Because of the annual renewal of the gift tax limit, you can take advantage of this and disburse the gift amount over several years.
Let's say you want to give your nephew $35,000 for his birthday. To avoid exceeding your yearly gift limit, a possible solution could be giving him the $16,000 this year, another $16,000 next year, and the remaining $3,000 directly to his school for tuition.
Structuring the gift is a practical when giving cash or investment securities but won't help if you're giving real estate. For example, if you give someone a house that exceeds your lifetime annual limit, you will have to pay the gift tax. However, there are some ways to break the ownership of large assets to avoid these situations, and the next section will explore this in more detail.
How to Avoid Gift Tax on Property
Giving property as a gift usually takes place as a one-time payment. And if the house costs more than $12.06 million, you will exceed your lifetime exclusion limit and pay the federal gift tax.
Nevertheless, the tips and tricks on how to avoid gift tax on property are pretty much the same as for other asset types:
- For example, if you want to gift your two children a house worth $23 million, you can give them joint ownership, and each of them would own 50% of the house. Even though you would reach your lifetime tax exclusion limit, you would avoid paying a gift tax for the home.
- Alternatively, if you are a married couple, you can give up to $48 million worth of property to your two children without any tax consequences.
- You can also gradually transfer the house’s ownership to the recipient to avoid gift tax. Let's say you buy the house for $250,000 and give only 12.8% of the ownership to your two kids. This would not exceed the annual tax limit. Then, you can pass more of the ownership every year until the property is entirely gifted.
Sum Up
The gift tax is a tax that the IRS imposes on individuals for giving valuable gifts in the form of cash or other assets. Every citizen can give up to $16,000 annually and $12.06 million during their lifetime before the tax will actually be applied.
Many people avoid paying the gift tax simply because they don't reach the abovementioned limits. However, if you're planning to give someone something valuable and don't want to be involved in extra paperwork, you can either structure your gift over several years or give a joint gift with your spouse to increase the total tax limit. Another option is to pay directly to the recipient's school or clinic if your gift involves covering their tuition or medical bills.
FAQ
If you're looking for additional information on gift tax, here are some frequently asked questions:
Who Pays the Gift Tax?
The person who gives the gift is liable for paying the gift tax. However, under special circumstances, the recipient may claim to pay the tax instead. We suggest you contact a tax professional for further details about this arrangement.
What is Considered a Gift?
A gift is any transfer to an individual where the individual giving the gift does not receive anything in return. Therefore, a gift can include money, property, or objects.
What Kind of Gifts Are Exempt from Taxation?
Typically, any monetary contribution to the recipient is considered a gift. However, there are some exceptions when you won’t be taxed if you exceed the gift tax limit. Those include:
- Gifts to your spouse or dependents
- Gifts to political organizations for their own use
- Paying for someone’s medical expenses by contributing directly to the medical institution
- Paying for someone’s tuition by contributing directly to the educational institution
What Information Should I Include for Filing the Gift Tax Return?
The donor must attach a copy of the IRS Form 709, available on the IRS's website for download.
You may be interested in these blogs, too:
