The Annual Gift Tax Exclusion

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This week we are talking about giving the gift of money! Last week we talked about putting your child on the payroll if you have your own business and how it can save you money in taxes and how it can go to your child tax free. If you missed that episode and you have your own business, you will definitely want to go give it a read or a listen HERE!

What if you don’t have your own business or your child isn’t ready to work in your business or you just want to transfer money to them? That is where the Annual Gift Tax Exclusion comes in! But before we talk about that, there is one other thing you need to know about and that is the Estate and Gift Tax Exemption, also called the Lifetime Gift Exclusion. The Estate and Gift Tax Exemption is the amount you can transfer during your life or at death without incurring estate or gift tax. For 2023, that amount is $12.92 million per person! That amount is transferable between spouses so a married couple in essence would have $25.84 million in 2023! While most people do not have assets or an estate that would exceed this number, it’s important to note that, unless Congress makes it permanent, that current large amount of $12.92 million and $25.84 million for a married couple is only temporary and is set to revert back to about $6 million beginning in 2026. $6 million is a number that would affect a lot more people’s estates and assets. There has even been political discussion of lowering it even more. That being said, it could greatly affect a lot of people, especially if they don’t plan ahead.

Now, that brings us back to the Annual Gift Tax Exclusion.

So how does the Annual Gift Tax Exclusion fit into this? The Annual Gift Tax Exclusion is an amount you can gift each year that won’t affect that Estate and Gift Tax Exemption. For 2023, that amount is $17,000 per person per gift. So, a married couple can give $34,000 per recipient. That gift can go to anyone, not just your children, and to as many recipients as you would like. So, in 2023, you can gift $17,000 to as many people as you’d like and there would be no gift tax. However, if you gifted more than $17,000 then the excess would count against your Estate and Gift Tax Exemption. For example, if I gifted $27,000 to a friend this year, then the $10,000 excess would reduce my Estate and Gift Tax Exemption amount. Keep in mind, just because tax isn’t owed at the time of the gift doesn’t mean you don’t need to file a Gift Tax Return though!

Why is this Annual Gift Tax Exclusion important? First and foremost, there is the possibility (and likelihood) that the Lifetime Gift Exclusion, that Estate and Gift Tax Exemption amount, could be a much smaller number when you pass away. Considering the gift and estate tax can be as high as 40%, you want to minimize the amount of estate or gift tax you would have to pay. That is why planning at a young age is so important. Waiting until you are retired is often too late for effective planning. One thing that is interesting to note is that when gift tax is owed, it is paid by the giver not the recipient. And the estate tax is paid by the estate.

Let’s look at an example. If you are currently 40 and your total estate is worth $2 million then you are probably thinking that this doesn’t really affect you yet but you need to be thinking in the long term. Say you live to be 80. At 80, maybe your estate has grown to $10 million and let’s say the Lifetime Exclusion amount is $6 million at that time. Then $4 million of your estate would be subject to being taxed. By using the Annual Gift Tax Exclusion, you are able to get money out of your estate during your lifetime without it being subject to taxes because it doesn’t count towards your Lifetime Exclusion number at death.

You may now be asking, what can I gift? Is it only cash or can I gift other assets? You can gift cash or other assets such as jewelry or real estate. Although real estate is rarely going to be under $17,000. However, it is important to note what assets are ideal to gift and what assets are ideal to wait and leave to loved ones when you pass. The big deciding factor in what to gift now and what to gift later comes down to basis.

What do I mean by basis? By basis, I mean the amount the asset is valued at for transactional, and tax, purposes. For the Annual Gift Tax Exclusion, assets transfer at cost basis thus making cash a very ideal asset to gift. What cost basis means is the actual cost paid for the asset. If you bought a diamond ring for $12,000 and gifted it then the recipient would also have a basis of $12,0000. If you bought a piece of land 30 years ago for $15,000 and it is now worth $150,000 and you gifted it then the recipient would also have a basis of $15,000. This is where taxes would come back in. If that recipient sold the gifted land the day after you gave it to them for the market value of $150,000 then they would pay taxes on the gain of $135,000 (the $150,000 market value it was sold for less the $15,000 cost basis of the gift). On the flip side, if you waited to give that piece of land at your death then the recipient would get what is called a step up in basis, meaning that even though you paid $15,000 for that land, since it is now worth $150,000 then the recipient has a basis of $150,000 when they receive it after your death. If the recipient sold that land the next day for $150,000 then there would be no gain and no tax due.

You can see why there is definitely some planning and strategy that needs to go into what assets you gift now and what you leave at death. The more assets you have, the better you need to plan.

Maybe you want to gift your child some cash now but you are worried they aren’t responsible enough to save it or invest it as wisely as you would intend for them too. You can also create a trust and gift the money into that trust. If you go this route, I would highly recommend consulting an attorney that specializes in this area but this can be a great way to go if you have younger children or ones that are slow to mature. LOL.

While it can be a little morbid to think about planning for “death and taxes” when you are younger, it can make a big difference in maximizing the value of your hard work and your assets and minimizing taxes.

Since this has been a bit technical, let’s do a recap:

• Point #1: The Estate and Gift Tax Exemption, also called the Lifetime Exemption, is the amount of money and assets you gift during your lifetime and/ or at death without tax ramifications. While that number is $12.92 million per person in 2023, that number is currently set to decrease significantly. That means you want to get money and assets out of your estate before death.

• Point #2: The Annual Gift Tax Exclusion allows you to gift money and assets each year while you are living to reduce your total estate. As long as you don’t gift more than the annual exclusion amount, which is $17,000 in 2023, then your Lifetime Exclusion won’t be affected. It is important to note that the Annual Gift Tax Exclusion amount has historically increased each year and will most likely continue to do so.

• Point #3: Planning which assets to gift while alive and which ones to pass along at death can make a big difference in the recipient’s basis in that asset. Assets that have increased in value versus their original cost are the ones you will most likely want to gift at death so the recipient gets that stepped up basis and minimizes taxable gains on the sale of the asset.

You work hard and want to maximize how much you are able to give your children and loved ones rather than Uncle Sam. Making a long term plan is ideal to achieve that goal!

NOTE: This information is for federal tax purposes. States will vary.

Information contained in this post is for educational purposes only and is not considered financial advice.