Gift tax: Explanation, examples and more

Giving a gift to a relative or friend may give you a feeling of joy. But it also can unwrap plenty of sticky tax issues. In some cases, the IRS may hit a gift giver with the federal gift tax. Whether a gift giver pays this tax, which can be as high as 40%, depends on factors such as the type of gift and the giver’s annual and lifetime gift limits.

Read on to learn more about what the gift tax is and how it works.

Key takeaways

• The federal gift tax applies to the transfer of assets, such as cash or real estate, from one person to another.

• The federal gift tax ranges from 18% to 40%.

• If a gift tax is due, the gift giver is responsible for paying it rather than the gift recipient.

• A gift giver may be able to avoid paying the gift tax, depending in part on the type of gift and the gift giver’s IRS-imposed annual and lifetime gift limits.

The federal gift tax is a tax on the transfer of assets by a living person when that person receives nothing in return for the gift or receives less than the gift’s full value. The gift giver, not the gift recipient, is responsible for paying the tax to the IRS.

Cash and real estate are among the types of gifts that the IRS might tax. Assets valued at less than a certain dollar amount are exempt from the gift tax. Also, the tax does not apply to certain gifts, such as tuition paid directly by the donor or a gift to a spouse.

The gift tax should not be confused with the estate tax. The gift tax applies only to the assets that are gifted by a living person, while the estate tax applies to a deceased person’s estate if it’s worth above a certain exemption threshold.

The gift tax prevents someone from avoiding the estate tax by transferring assets when they are alive.

For 2023, the IRS allows a $17,000 gift tax exclusion, up from $16,000 the previous year. This limit means that someone can give as much as $17,000 worth of assets to another person in 2023 without paying the gift tax.

The IRS does not restrict how many tax-free gifts can be given in a year’s time. So, if you have three children, you could give each child up to $17,000 in assets in 2023 without being taxed.

The IRS also allows a lifetime gift tax exclusion. For 2023, the amount is $12.92 million, up from $12.06 million the previous year. Under this exclusion, someone can give gifts totaling $12.92 million throughout their life without paying gift taxes.

The IRS adjusts the gift tax exemption each year to account for inflation.

The federal gift tax applies to the transfer of property by one person to another without the expectation of getting something of value in return. The IRS relies on the fair market value of the property at the time the donor made the gift to determine whether taxes are owed.

Examples of property that qualifies as a taxable gift include:

• Cash

• Real estate

• Stocks

• Bonds

• No-interest loans

• Artwork

• Vehicles

Remember: The IRS imposes the gift tax on the person giving a gift, and not the person receiving a gift. If someone gives a gift that exceeds the annual gift tax exclusion—$17,000 in 2023—they likely will need to file IRS Form 709. The gift giver should file this form with their tax return for the tax year when the gift was made. However, filing Form 709 doesn’t automatically result in being required to pay the gift tax.

The gift tax rate, ranging from 18% to 40%, depends on how much the value of a gift exceeds the giver’s exemption limits:

Several types of gifts are exempt from the gift tax. They include:

• Gifts to eligible charities

• Gifts to a spouse who is a U.S. citizen

• Direct payment of medical expenses

• Direct payment of tuition

The gift tax is assessed depending on several factors, such as the type of gift and the gift tax limits that are in place.

Let’s say a parent gives each of their two adult children $25,000 in cash in 2023. These gifts are considered taxable since they surpass the annual $17,000-per-recipient exclusion. However, taxes will be due on these gifts only if the parent already has reached the lifetime exemption limit. Even if taxes are not due, the $50,000 in total gifts still counts toward the lifetime exemption limit.

Now, let’s say a niece has already reached her lifetime exemption limit and gives a painting worth $10,000 to her aunt. In this case, the $10,000 gift would be subject to an 18% gift tax.

In another scenario, let’s say a grandfather pays his college-age granddaughter’s $10,000 tuition for the 2023-24 school year. This gift typically would not be taxed because tuition paid directly to an educational institution is not subject to the federal gift tax.

Fortunately, strategies are available to minimize the impact of the gift tax. They include:

• Gift splitting: Gift splitting enables a married couple to give twice as much as an individual while escaping gift taxes. So, this means a couple could give $34,000 in gifts to one person in 2023 without triggering tax implications.

• Gifts in trust: A gift in trust lets someone give a gift to a beneficiary in excess of the annual gift limit in order to avoid the gift tax.

• Spreading out the gift over a few years: By spreading a large gift across several years, a donor may be able to limit their gift tax liability as long as the annual cap is not exceeded.

• Giving nontaxable gifts: Choosing gifts that are exempt from the gift tax—like direct payment of someone’s tuition or medical expenses—is another tax-saving strategy.

The federal gift tax applies to the transfer of assets from one person to another. And knowing what the annual and lifetime limits are for giving gifts can help a donor avoid gift taxes.

If a gift giver is subject to the gift tax, their tax rate may range from 18% to 40%, resulting in a potentially hefty tax bill. So it’s wise to consult with a tax professional on the tax implications before giving a substantial gift.