Let’s say you’re someone who wants to give money to two people: your son and his wife. Maybe it’s to help with a wedding, a down payment on a house, or starting a family.
You can probably give away a good amount of money without having to pay taxes on it, but there may be other hoops to jump through. In 2024, you can give away up to $18,000 to each recipient without having to report it to the IRS. You can then give away another $13.61 million tax-free over your lifetime, although you must report such transfers. In 2024, you could theoretically give your son and daughter-in-law a maximum of €13,646,000 tax-free. If you’re married, you can probably give even more. However, it’s a little more complicated than that, so read on to learn how the gift tax works.
Consider hiring a financial advisor. He or she can help you develop a strategy to make gift giving to your family as effective as possible.
What is gift tax?
The gift tax is a hybrid tax on gifts and other transfers. It partly overlaps with inheritance tax, which is where the ‘hybrid’ part comes into play.
The IRS defines a gift as “the transfer of property from one individual to another for nothing or less than its full value in return.” Basically, you trigger this tax when you give someone property or assets without getting an equivalent value in return. Equivalent value (or “full value”) is a reasonableness test. You don’t have to prove your trade to any market surety, just that a reasonable person could see it as a fair trade.
The gift tax only applies to transfers of ownership. Personal services do not apply, nor does lending someone or accessing your property. For example, let’s say you are a CPA. Doing your friend’s taxes isn’t a transfer, nor is letting him stay at your beach house for a week, even though both have market value. You must give them ownership of the actual assets.
Gift tax usually arises in three situations:
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Unilateral transfers, where you give up assets without getting anything in return.
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Low-value transfers, where you gift assets and get back less than their full value.
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Low or no interest loans, where you provide a loan and charge significantly less interest than the market interest rate.
Lawyers use the 19th century example of a “peppercorn promise” to illustrate low-value transfers. Suppose your friend offers to sell you his car in exchange for a peppercorn. This would be a gift disguised as a sale, because even though you are technically exchanging assets, the value of the car dramatically exceeds 1/16 teaspoon of spice. The taxable value of this gift would be the difference in value between the car and the peppercorns.
Finally, the IRS exempts several categories of transfers from gift taxes. For example, direct tuition and medical payments generally do not count as taxable gifts, regardless of the amount.
For help navigating the complexities of gift tax law, consider consulting a fiduciary financial advisor.
Gift tax exclusions and rates
Like estate taxes, few households will ever pay gift taxes. This is due to the high annual and lifetime exclusions, which are amounts you can give away without triggering gift taxes.
Annual exclusions
The annual exclusion is the amount you can give away each year without reporting it to the IRS. The annual exclusion applies per donor and per recipient. This means that you can give away to an unlimited number of people each year up to the annual exclusion without having to report it. In 2024, the annual exclusion will be $18,000, and the IRS generally adjusts it for inflation each year.
The annual exclusion is extended every year. This means that the amount you can give tax-free in a given year has no relation to donations you have made in previous years.
For example, in 2024 you can give $18,000 to your son and another $18,000 to your daughter-in-law without reporting these transfers to the tax authorities or paying taxes. Then that will be possible again in 2025.
The annual exemption has nothing to do with inheritance tax.
Lifetime exclusions
Once you exceed the annual exclusion for a particular recipient, you must report any additional gifts to the IRS using Form 709. This form is filed with your annual taxes, not at the time you make the gift.
Gifts in excess of the annual exclusion will apply to your lifetime exclusion. This is the amount that you can transfer tax-free throughout your life, both as gifts and as inheritances. It applies cumulatively to you personally, regardless of the recipients. In 2024, the lifetime exclusion will be $13.61 million.
The lifetime exclusion is not renewed annually. Although the IRS increases the limit every year to account for inflation, each transfer you make permanently reduces your lifetime exclusion.
For example, suppose you give $22,000 to your son and $25,000 to his wife. Together, this is a combined amount of $11,000 in gifts above the annual exclusions ($4,000 for your son and $7,000 for your wife). You would report to the IRS on Form 709 that there are $11,000 in gifts and your lifetime exclusion would be reduced by $11,000, possibly from $13.61 million to $13,599.00. That reduction won’t go away even if the IRS increases the inflation exclusion.
The lifetime exclusion is a shared exclusion for gifts and inheritances. During your lifetime, you can make any amount of gifts tax-free up to the amount you have left in your lifetime exclusion. You can then pass on assets in your estate tax-free to your heirs up to the amount you have left in your lifetime exclusion.
Gift tax rates above the exclusion amounts
If you make a gift that exceeds both your annual exclusion to that person and your remaining lifetime exclusion, you will pay tax on the remainder. Gifts and inheritances are taxed at 18% to 40%, depending on the amount involved.
For example, let’s say you have $110,000 left in lifetime exclusion in 2024. This means that over the course of your life, you’ve given away $13.5 million above your annual exclusion each year to various individuals and organizations. You now want to give $100,000 each to your son and daughter-in-law. Here’s how your taxes would work:
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Son’s annual exclusion: $100,000 – $18,000 = $82,000
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Daughter-in-law’s annual exclusion: $100,000 – $18,000 = $82,000
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2024 Reportable gifts: $82,000 * 2 = $164,000
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Lifetime Exclusion: $110,000 – $164,000 = -$54,000
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Taxable gift: $54,000
You don’t report gifts up to the annual exclusion for each recipient ($18,000 in 2024). Then you can reduce any reportable gifts by the amount left in your lifetime exclusion. Since your reportable gift exceeds your lifetime exclusion, you owe taxes on the remaining $54,000.
Only the donor must file a return and pay the gift tax. Gifts are generally not considered taxable income and the recipient does not have to pay gift tax.
A financial advisor can help you draw up an appropriate donation and estate plan. Talk to a financial advisor today.
How much can you give away?
So, all that being said, how much can you give away to your son and his wife? The answer depends in part on how much you’ve given in your lifetime so far. If you’ve given gifts in the past that exceed your annual exemption for a recipient, your lifetime exemption will be reduced by that amount. However, assuming you still have your full lifetime exemption, the most you can give your son and daughter-in-law tax-free, assuming you’re single, is:
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Son’s Annual Exclusion: $18,000
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Daughter-in-law’s annual exclusion: $18,000
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Lifetime exclusion: $13.61 million
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Total Donations 2024: $13,646,000
You can give them the total value of your annual exclusion per person, plus the total lifetime exclusion, for a total tax-free gift of $13,646,000. However, keep in mind that if you do that, you will use up your money whole Lifetime exclusion. Future transfers through gifts and your estate may be taxed.
Double your gift by splitting gifts
Finally, there is gift splitting. This refers to the fact that each member of a married couple receives their own annual and lifetime exclusions, even if they file taxes jointly. So say you’re married. Under the annual exclusion, you can give your son and his wife up to $18,000 each in 2024. Your spouse can give your son and his wife up to $18,000 each under her own annual exclusion, for a joint gift of $72,000 from one household to the other.
If you split a gift, you must file Form 709. This allows you to let the IRS know how you distributed the gift among the members of your household. For example, suppose you give your son $30,000. You will then need to file Form 709 so that you and your spouse can each claim $15,000 toward your annual exemption.
Gift splitting also applies to lifetime exclusions. If you are married, your household will have $13.61 million per spouse to transfer tax-free in 2024 for a combined maximum gift of $27.22 million. Once you exceed your annual exclusion, you can split gifts between your lifetime exclusions and your spouse’s. So if you are married and want to give money to your son and his wife, you can theoretically give them up to $27,292,000 in 2024 tax-free.
Splitting gifts can get complicated. Consider consulting a financial advisor who can help you navigate the rules.
It comes down to
Gift tax applies to any unilateral transfer or any exchange when you give away assets for less than their full value. Each year, the IRS allows you to gift any amount tax-free to any number of recipients, and over your lifetime you can give away more than $13 million without paying taxes on it.
More resources
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The gift and inheritance tax is a hybrid tax on unilateral transfers, as we discussed above. However, like the gift tax, the inheritance tax has its own rules that only apply to post-mortem transfers. Here’s what you need to know.
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