If you have the means, making financial gifts to your loved ones can allow you to help set them up for success — and enjoy seeing them benefit from your gifts. But as the value of your gifts grows, the IRS may start to show an interest (your state revenue department might, too). So, as you make financial gifts, it’s important to understand how gift tax rules work. By arming yourself with a little knowledge and collaborating with an experienced financial professional, you can help minimize gift tax consequences.
What is the federal gift tax?
While each state has its own gift tax rules, in this piece, we’re going to focus primarily on federal gift tax. Basically, the federal gift tax is a tax levied on property you transfer to someone else during your lifetime without expecting to receive something of equal value in return. Gifts include more than just money. In fact, anything that has monetary value is subject to gift tax. That could include:
- Life insurance policies
- Real estate
- Fine art
For non-cash gifts, gift tax rules apply based on each gift’s fair market value.
6 ways to leverage federal gift tax rules
If you’ve heard that you can gift up to a certain dollar amount each year to anyone without incurring federal gift tax, that’s true. It’s all thanks to the annual gift tax exclusion (see more below). But what you may not know is that if you are looking to gift more than this amount in a given year, there is a strong chance you still can without incurring federal gift tax or impacting your lifetime gift and estate tax exemption.
Here are six simple ways to make financial gifts without incurring federal gift tax:
1. The annual gift tax exclusion
The annual gift tax exclusion is probably the most well-known federal gift tax exclusion. It enables each person to gift up to a certain amount of money (the annual exclusion amount) to any other person in a given year. What’s more, the Internal Revenue Service (IRS) adjusts the annual exclusion amount for inflation annually. In 2023 the annual gift tax exclusion is set to $17,000, up from $16,000 in 2022.
The annual gift tax exclusion is straightforward. You can make a financial gift to literally any other person up to the annual exclusion amount in a given year, and no further action is required. You won’t have to pay gift tax on the gift you made, and you won’t have to report your gift to the IRS via Form 709 (also known as the gift tax return).
2. Gift splitting
If you are married and want to give someone more than the annual exclusion amount, you can leverage an estate planning tool called “gift splitting.” Because each American is entitled to an annual gift tax exclusion, as a couple you can jointly give up to two times the annual exclusion amount. In 2023, that means as a couple you can gift up to $34,000 to any one person without federal gift tax consequences.
3. Tuition gift tax exclusion
If your financial gift is for educational purposes, another gifting option is the tuition gift tax exclusion. Essentially, this exclusion allows you to cover the cost of someone else’s tuition without it impacting your ability to make an annual exclusion gift to that person. And this isn’t just for college education; educational programs ranging from nursery school and preschool all the way through post-secondary may qualify.
However, before you make a tuition gift, you need to know these details:
- The educational institution must meet certain criteria. As a part of that, the law says that the institution must be "an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” In other words, formal instruction must be the organization’s primary focus, which may disqualify some organizations.
- Payment must be made directly to the school on behalf of the student attending.
- While there is no cap on the tuition exclusion, the money you pay directly to the school is not refundable.
- The tuition gift tax exclusion does not apply to room, board, books and other costs that do not constitute direct tuition costs.
- If the student you are assisting receives financial aid, the institution may adjust the student’s financial aid award because of your gift.
Before making a tuition gift, it’s smart to consult with your financial advisor, attorney and/or tax professional to ensure your gift qualifies for the exclusion. What’s more, if the student is receiving financial aid, consider reaching out to the institution’s financial aid department to understand the impact, if any, your gift will have on the student’s financial aid award.
4. Accelerated 529 gifting
Accelerated 529 gifting is another option for education-related gifts. This special feature of 529 college savings plans allows you to make up to five years of annual exclusion gifts in one year as long as the gift is deposited into a 529 account.
In 2023, that means you can contribute up to $85,000 if you are single (up to $170,000 if you are married) to any person. To take advantage of the five-year accelerated gifting provision, you’ll need to file a gift tax return with the IRS for the year the contribution was made. And, because you are accelerating future annual exclusion gifts, it’s important to remember that other gifts made to this individual during the five-year period may be subject to federal gift tax if those gifts do not otherwise qualify for a gift tax exclusion and your lifetime gift and estate tax exemption is exhausted.
5. Medical gift tax exclusion
There is also a special exclusion if you are looking to help someone pay for medical expenses. Like the tuition gift tax exclusion, the medical gift tax exclusion is unlimited and has no impact on any annual exclusion gifts for the recipient.
While the rules around what expenses qualify for the medical gift tax exclusion are broad and even enable you to help pay for health insurance premiums and long-term care, there are a few important rules to know:
- The gift cannot pay for costs covered by insurance.
- Generally, this exclusion does not apply to costs for cosmetic surgery.
- Payments must be made directly to the health care provider or health insurer.
If you’d like to make a medical gift tax exclusion gift, reach out to your financial advisor, attorney and/or tax professional to help ensure your gift qualifies for the exclusion.
6. The lifetime gift and estate tax exemption
While there are limits to what can be given under the aforementioned exclusions, it’s possible to give more without owing tax. Every U.S. citizen or resident gets a lifetime exemption amount that offers you the ability to distribute a certain value of property to others during your lifetime and/or at death without incurring gift tax or estate tax. It’s important to note that this exemption is a unified exemption, so gifts made using this exemption can impact the total exemption remaining for the property you transfer at death through your estate.
Thanks to the Tax Cuts and Jobs Act (TCJA) of 2018, the lifetime gift and estate tax exemption amount doubled from $5.49 million in 2017 to $11.18 million in 2018. The IRS also adjusts the exemption amount annually for inflation, so in 2023 the exemption amount is set to $12.92 million for single individuals and $25.84 million for married couples. This means that after exhausting the previously discussed gift tax exclusions, you can still gift up to an additional $12.92 million (or $25.84 million for married filing jointly) to any combination of individuals over the course of your lifetime without incurring federal gift tax. However, such gifts may reduce your ability to gift or bequeath property free from tax in the future.
At current levels the lifetime gift and estate tax exemption only affects people with substantial assets. However, it’s important to highlight that TCJA provisions are set to expire in 2026. This means that without congressional intervention, the lifetime gift and estate tax exemption will be reduced by approximately half. Still, even at that level, the majority of people will likely never be in a situation in which they will owe gift tax or estate tax.
You may still owe state taxes
While the federal gift tax exemptions are quite high, states may have different rules. So be sure to speak with your financial advisor, attorney and tax professional to help determine if you live in a state that levies its own gift tax and, if you do, what steps you can take to help plan for it.
Gifting strategically to meet your goals
Whether you are planning to make a one-time gift or embark on a years-long journey of gifting to your loved ones, it’s important to consider how you can minimize gift tax consequences and how your gifts will impact your overall financial picture. That’s where the help of an experienced financial advisor comes in. Together, you can identify an effective gifting strategy that meets your long-term financial and life goals.
This publication is not intended as legal or tax advice. Consult with a tax professional for tax advice that is specific to your situation.
As an attorney in Sophisticated Planning Strategies, I work with Northwestern Mutual financial advisors as they help clients achieve financial security.
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