How do gift taxes work?
During this holiday season, let's talk about gifts and gift taxes
Happy Wednesday!
Hope you and your family enjoyed a nice Christmas and are ready for 2024!
This is the time of year when many gifts are given.
And while giving someone a gift card or gadget is pretty straightforward, I’ve found there’s often a lot of confusion when it comes to giving someone a financial gift.
I’m not talking about $50 here or $100 there.
This has to do with the annual gift tax exclusion amount and how it relates to your lifetime gift tax exclusion.
Back in February of 2022 I addressed this in a podcast episode which you can check out here:
But for those of you who would rather read than listen, I wanted to revisit this topic…
As you may know, the IRS sets an annual dollar amount that you can gift to another person without any tax consequences or tax filing requirements.
And these amounts apply whether you’re giving someone cash or shares of a mutual fund.
In 2023, the amount is $17,000, and in 2024, the amount - also known as the annual gift tax exclusion - will be $18,000.
That seems pretty straightforward and most people seem to get it.
Where I find confusion among people I talk with is what happens if you give someone more than the annual gift tax exclusion amount in one year…
Many people seem to believe that if you give a person one penny over the annual gift tax exclusion amount, the IRS will show up at your door to collect gift taxes.
Thankfully, that’s not true.
You can give quite a lot of money away each year, irrespective of the annual exclusion amount.
But if you do, any amount over the annual exclusion - let’s use $18,000 for 2024 as an example - will require that a gift tax return be filed.
Note that I didn’t say that any gift tax will need to be paid.
You see, in addition to the annual gift tax exclusion amount, each person has a lifetime gift tax exclusion amount.
Confused yet? Keep reading…
For 2023, the lifetime exclusion amount is $12.91 million.
For 2024, the lifetime exclusion amount will be $13.61 million.
So let’s say in 2024, you want to give $30,000 to your daughter.
The first $18,000 doesn’t count against your lifetime exclusion amount.
But the remaining $12,000 of the $30,000 gift reduces your lifetime exclusion amount.
Before the 2024 gift, your lifetime exclusion amount is $13,610,000.
After the 2024 gift of $30,000, your lifetime exclusion amount is reduced by $12,000 and will now be $13,598,000.
Gifts up to the annual gift exclusion amount never counts against your lifetime exclusion amount.
And the reason the IRS wants a gift tax return filed if you give more than the annual exclusion amount is so they can keep track of how much of your lifetime exclusion remains.
So to recap…
You have an annual gift tax exclusion amount. In 2024, it’s $18,000.
You can give as many people as you want up to $18,000 in 2024 without a second thought.
However, as soon as you give a single person more than $18,000 in 2024, you’ll start chipping away at your lifetime gift tax exclusion amount. This lifetime exclusion is $13.61 million in 2024.
And any gifts over the annual exclusion limit will require that you file a gift tax return.
No one owes anyone any gift taxes until you’ve given away $13,628,000 or more in 2024.
Where did that $13,628,000 figure come from?
That first $18,000 is free of any gift taxes. The next $13,610,000 is your lifetime exclusion amount.
Above that lifetime exclusion amount you’ll owe gift taxes which can range from 18% to 40%. And it’s generally the giver that owes the gift taxes, not the recipient.
And to throw one more wrinkle into this discussion of gift taxes and exclusions, these numbers may change as soon as 2025.
I wrote a few months ago about the coming “sunset” of many current estate planning taxes which you can read here:
Well, these gift tax rules and limits generally fall under the estate planning regulations.
So if no new legislation is passed before the end of 2024, in 2025 the lifetime gift tax exclusion drops from $13.61 million in 2024 to $5 million (adjusted for inflation) in 2025.
And while you may have zero plans to start giving money away, I wanted to attempt to provide some clarity around these rules and how they work.
If you have any questions about this or would like to discuss anything else, please get in touch.
For now, I hope you have a Happy New Year!
Thank You!
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Until next Wednesday,
Russ