The Federal Gift Tax is important to understand within estate planning because of its implications for estate planning strategies. This article offers a basic overview of the Gift Tax.
What is the Gift Tax?
The Gift Tax is a federal tax on the donor of any gift above the annual exclusion amount.
For 2021, the annual exclusion amount is $15,000 per individual recipient. Therefore, you must file a Gift Tax return for any gifts over $15,000 that you give to a single individual.
However, every gift donor has a lifetime exemption amount. So, while you must file a Gift Tax return on every gift above $15,000—you only need to pay if you have exceeded your lifetime exemption. The lifetime Gift Tax exemption amount is equal to the Federal Estate Tax exemption amount. In 2021, this amount is $11,700,000 per individual and $23,400,000 for a married couple.
What is a “Gift?”
The IRS describes a “Gift” as “Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”
An important aspect of the IRS’ definition is that it includes anything for which you do not charge full fair market value. For example, if you sold your child a $30,000 car for $500—you gave them a “Gift” of $29,500. In this scenario, you would need to file a Gift Tax return for $14,500 (remember that the first $15,000 is excluded).
There are, of course, certain types of gifts that are excluded regardless of these amounts; those generally include:
1. Gifts under the annual exclusion for the year.
2. Tuition paid on someone’s behalf.
3. Medical expenses paid on someone’s behalf.
4. Gifts to one’s spouse.
5. Gifts to a political organization.
6. Gifts to qualifying charities are deductible from their value.
How does the Gift Tax affect estate planning?
The Gift Tax becomes relevant in the context of estate planning because the “used” portion of your lifetime Gift Tax exemption is subtracted from your Federal Estate Tax exemption.
For example, if you gifted $4 million during your lifetime (and you died in 2021)—your estate would be taxed on anything more than $7.7 million instead of $11.7 million.
Likewise, many of these principles—such as unlimited gifting between spouses—are used in various estate planning strategies when dealing with high-net-worth estates.