Find out more about the lifetime exemption on the gift tax, the annual exclusion, and how all of this impacts your estate taxes.
How Does the Lifetime Gift Tax Exemption Work?
The lifetime gift tax exemption is adjusted for inflation every year, and it’s allowed for both spouses in a married couple. For example, the 2022 exemption is $12.06 million. If you are married, you could give away $24.12 million ($12.06 million each) without ever having to pay the gift tax. Even if you don’t exceed the lifetime exemption amount, you may still be required to file gift tax returns. The gift tax and the estate tax share the same exemption, often referred to as the “unified tax credit.” The amount is adjusted to keep pace with inflation, often on a yearly basis.
How the Annual Gift Tax Exclusion Works
The annual gift tax exclusion is $16,000 for tax year 2022 and $17,000 in 2023. You can give up to this amount in money or property to any individual per year without filing a gift tax return. The exclusion is per person, per year. So, your gifts can total $32,000 for the year if you want to give two people each the annual exclusion amount. You’d have a choice to make if you wanted to give your child $20,000 in calendar year 2022. In some cases, you could pay the gift tax on the additional $4,000 over the $16,000 annual exclusion. Or, you could apply it to the unified lifetime exemption.
The Unified Tax Credit
Your gift tax exclusion applies to gifts you give when you’re alive, and there’s a similar exclusion that applies to assets you leave to beneficiaries when you die, known as the estate tax exclusion. Together, these exclusions are known as the unified tax exemption or unified tax credit. You can use the unified credit to shelter your estate from taxation when you die. And you can use it to defray the tax burden of giving more than the annual gift tax exclusion to any individual in a given year. But the exemption is shared between these two taxes. So if you use up $5 million of your lifetime gift tax exclusion, your heirs would only have a $7.06 million exemption from federal estate taxes in 2022. Let’s take a look at an example where you have gifted someone $20,000 in 2022, leaving you $4,000 over the annual exclusion. You could file a gift tax return using Form 709 if you want to apply that $4,000 overage to the unified credit. You would indicate on the return that you want to choose that option. The $4,000 would then be deducted from your lifetime exemption. You would have $4,000 less to protect your estate from estate taxation when you die. Of course, $4,000 would hardly be missed from an $12.06 million exemption. This might be a pretty good deal if you have well below $12 million or more in assets. But the point is that using the unified tax credit to cover gifts in excess of the annual inclusion can cost your estate money that would otherwise go to your heirs if you give away considerable wealth by the time you die—enough that the $12 million or more unified credit might not shelter your entire estate.
Some Gifts Are Tax-Free
Some additional exemptions and provisions exist for special gifts. You can pay a student’s qualifying tuition expenses free of tax in any amount without incurring the gift tax, provided you give the money directly to the educational institution. You can also give as much as you like to qualified charities without incurring a gift tax, as long as they’re approved by the IRS. You can pay someone else’s medical bills, up to any amount, as long as you pay the care providers and institutions directly. As with the exemption for tuition, the money can’t pass through the beneficiary’s hands.
Splitting Gifts If You’re Married
Marriage doubles your annual exclusion. You can “split” your gifts with your spouse. Remember that $20,000 you gifted your child that went $4,000 over the $16,000 annual exclusion? Only $10,000 of that would count against each of your annual exclusions if you split the gift with your spouse. You can also give to your spouse to your heart’s content without incurring a gift tax, as long as they’re a U.S. citizen. Gifts to a non-citizen spouse are excluded up to a total of $164,000 per year for tax year 2022 and $175,000 for 2023.
The Bottom Line
The lifetime gift tax exemption lets the average American give a lot of money and property tax-free. Think about consulting a CPA or an attorney before deciding to dip into it if you expect that your estate will be sizable.
