You want to make sure your loved ones can keep as much of their inheritance as possible. Nobody wants to see their legacy get chipped away by a large tax bill, but that’s exactly what could happen to your estate without careful planning.
What Is the Gift Tax?
The first thing to know about the federal gift tax is that gift givers—not gift recipients—have to pay it. Thankfully, you won’t owe the tax until you’ve given away more than $11.7 million in cash or other assets during your lifetime, as of 2021.
This means that under current law, for estates under $11.7 million ($23.4 million for a married couple) no gift tax would be assessed. However, the current law is set to expire in 2026, when the exclusion amount will drop back down to $5 million (adjusted for inflation). At that point, estates over $10 million for married couples would be subject to a 45% tax.
To put that into perspective, a married couple worth $15 million would pay almost $2.5 million in estate taxes. That is why families are now looking to make gifts during their lifetimes that will reduce their estate tax exposure. One good tool is the annual gift tax exclusion amount.
How Does the Annual Gift Tax Exclusion Work?
In 2021, the annual gift tax exclusion amount is $15,000 per person. This means that if you’re married, you and your spouse can gift up to $30,000 to each of your children each year without increasing your estate tax exposure. If your children are married, you can also give $30,000 to their spouses, for a total of $60,000 per child.
This provides a meaningful way to get money out of your estate on an annual basis while benefitting your children right now. For example, a married couple with four children who are all married could gift $240,000 annually without incurring any gift tax, thereby reducing their potential estate tax by $120,000 each year. This is very real savings in estate tax.
Annual exclusion gifts can also be made to grandchildren. These can be in a trust or as contributions to 529 plans. Under current law, up to five years of annual exclusion gifts ($75,000) can be made in a single year to a 529 plan per beneficiary. This assumes no other gifts are made to that beneficiary in another form and that no additional gifts can be made to that beneficiary for the next five years.
What Happens If I Exceed the Annual Gift Tax Exemption?
If you exceed the annual gift exclusion, you’ll need to report that gift with the IRS, but there are likely to be no lasting tax consequences for you. The reason is that $11.7 million lifetime gift exclusion amount.
Let’s say you’re single and want to gift your child $25,000 this year so they can put together enough money for a down payment on a house. Because you exceeded the annual gift tax exclusion by $10,000, you would have to report that with the IRS; you wouldn’t have to pay any taxes on that $10,000. All that would likely happen is that your lifetime gift tax exclusion (the $11.7 million referenced earlier) would be reduced by $10,000. No significant tax consequences would come into play until you’ve used up your $11.7 million lifetime gift tax exclusion.
Do I Need to File a Gift Tax Return?
If you make a taxable gift (one in excess of the annual exclusion), you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return, even if you don’t actually owe any gift tax because of the $11.7 million lifetime exemption.
The form is due by the tax filing deadline, typically May 17 of the year after you make the gift—the same deadline as Form 1040 (if you extend your 1040 to October 15, the extended due date applies to your gift tax return too).
If you’re married, you can’t file a joint gift tax return. Each spouse must file a separate return if he or she makes any taxable gifts. You can, however, choose to “split” gifts with your spouse. Making a split gift allows you to take advantage of your annual gift tax exclusion plus your spouse’s exclusion for a gift that is made entirely by you. Keep in mind, if you choose to make a split gift, you must file Form 709, and your spouse must consent to the arrangement.
Gifting Doesn’t Have to Be a Tax Headache
If it seems like there is a lot to consider when you’re planning your gifting and estate planning strategy, that’s because there is. With the complexity of tax planning, you might be leaving money on the table. Working with trust and estate planning professionals that take your whole financial life into account can help limit your tax liability and maximize your gifts to loved ones.
This information is not intended to be a substitute for a specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
JD With more than 15 years of experience as a trust officer and estate planner, David crafts organized solutions for clients’ estate planning challenges. He helps clients identify their estate planning objectives, prioritize their wealth planning objectives, and structure wealth transfers to the next generation. He assists clients across the full range of estate planning, advising high net worth families, administering intricate trust relationships, and settling complex estates. Prior to...Read More