Navigating the Annual Gift Tax Exemption

Understanding the Annual Gift Tax Exemption

The annual gift tax exemption allows you to give money or assets up to a certain amount each year to as many people as you want, without triggering federal gift taxes or having to file a gift tax return. It's an important tool for estate planning, as it allows you to transfer wealth to your loved ones tax-free during your lifetime.

However, the rules around the exemption can be confusing. How much can you give? What counts as a gift? Do you always have to file a gift tax return? In this article, we'll demystify the annual gift tax exemption and show you how to use it effectively in your gifting strategy.

Current Gift Tax Exemption Amounts for 2023

First, let's cover the basics. For the 2023 tax year, the annual gift tax exemption is $17,000. This means you can give up to $17,000 to as many individuals as you want without those gifts counting against your $12.92 million lifetime gift tax exemption.

If you're married, you and your spouse can each make $17,000 gifts, effectively doubling the exemption to $34,000 per recipient per year. And if you make a gift to a married couple, you can combine your exemptions to give up to $68,000 to the couple with no gift tax consequences ($17,000 from you to each spouse, plus $17,000 from your spouse to each spouse).

These exemption amounts are tied to inflation, so they tend to increase slightly most years. But the $17,000 annual exemption is set for 2023. You can find the most up-to-date exemption amounts on the IRS website: Annual Exclusion.

What Gifts Are Covered by the Exemption?

The gift tax exemption applies to any transfer where you don't receive full value in return. In addition to cash and securities, it can apply to sales of property below market value, loans with below-market interest rates, the use of property rent-free, and more.

However, certain gifts are exempt from gift tax and don't count against your annual exemption:

• Gifts to your U.S. citizen spouse (non-citizen spouses have a higher annual limit)
• Gifts to a political organization for its use
• Payments for someone's tuition or medical expenses, if paid directly to the provider
• Gifts to charities

So if your child is in college, you can pay their tuition directly to the school without it counting against your $17,000 annual exemption for them. The same goes for paying a loved one's hospital bill. Just be sure to make the payment directly to the provider.

Do I Need to File a Gift Tax Return?

In most cases, you won't need to file a federal gift tax return (IRS Form 709) unless you give more than the $17,000 annual exemption to any one person in the calendar year. So if you write ten $10,000 checks to various family members, you're in the clear.

But there are a few scenarios where you'd need to file a Form 709 even if your gifts don't exceed the annual exemption:

• If you give a gift of future interest (where the recipient can't access the gift until a future date)
• If you give gifts from a trust that add up to more than the annual exemption per recipient
• If you and your spouse "split" gifts, where one of you gives more than the $17,000 but you want to apply both of your exemptions

In the "gift splitting" scenario, let's say you give your child $30,000. You can apply your $17,000 exemption and your spouse's $17,000 exemption (with their consent). This would bring the taxable amount down to $0, but you'd still need to file Form 709 to report the split gift.

If you do need to file Form 709, don't panic. In most cases, you won't actually owe any gift tax unless you've used up your $12.92 million lifetime exemption. The annual return is mostly just a formality and a way for the IRS to track your lifetime gifts.

Strategies to Maximize Your Annual Gift Tax Exemption

With some smart planning, you can transfer significant wealth to your loved ones tax-free by maximizing your annual gift tax exemption over time. Here are a few strategies to consider:

• Use it or lose it: The exemption doesn't carry over, so be sure to use your full $17,000 per recipient each year if you can afford to. A series of $17,000 annual gifts can really add up over a decade or two.

• Split gifts with your spouse: As mentioned, you and your spouse can each make $17,000 annual gifts. Consider coordinating to maximize your combined $34,000 exemption for each recipient.

• Give appreciating assets: Instead of cash, consider giving appreciating assets like stocks. The recipient gets the asset at your cost basis, and any future appreciation is out of your estate.

• Pay tuition and medical bills directly: Remember, these payments are gift tax-free over and above the $17,000 exemption, as long as you pay the provider directly.

• Consider a 529 plan: You can front-load five years' worth of annual exemptions into a 529 college savings plan. So you could put $85,000 ($17,000 x 5) into a 529 for your child or grandchild at once, and it counts as your annual exemption gifts for the next five years.

• Use trusts wisely: Gifts to certain trusts can qualify for the annual exemption while still providing control over when beneficiaries can access the funds. But tread carefully and consult with an estate planning attorney, as not all trusts are eligible.

Remember, it's always a good idea to discuss major gifts with your tax advisor or estate planner to ensure you're being tax-efficient and to document the gifts properly.

Avoiding Common Gift Tax Exemption Mistakes

As you incorporate the annual gift tax exemption into your estate plan, watch out for these common pitfalls:

• Exceeding the exemption unknowingly: Be sure to keep track of all your gifts throughout the year. Little checks, electronic transfers, and indirect gifts can add up to more than $17,000 before you know it.

• Assuming the recipient owes tax: The gift tax is the giver's responsibility, not the recipient's. So don't worry about sticking your loved ones with a tax bill.

• Failing to "split" gifts: If you plan to use your spouse's exemption too, you need their consent and signature on a gift tax return. Make it a habit to report split gifts.

• Gifting from joint accounts: If you give more than $17,000 from a joint account and want it treated as a "split" gift from both owners, document it. Otherwise, the IRS assumes the entire gift came from the person who signed the check.

• Not considering state tax: Some states have their own gift tax, so be aware of your state's rules too. Federal-level rules apply in most cases, but check to be sure.

• Waiting until year-end: You can make annual exemption gifts any time during the calendar year. Making gifts earlier gives the assets more time to appreciate out of your estate.

By steering clear of these mistakes and properly documenting your gifts, you can make the most of your annual gift tax exemption for years to come.

Putting Your Gift Tax Exemption Knowledge to Work

Armed with this knowledge, you're ready to put the annual gift tax exemption to work in your estate plan. Remember these key takeaways:

• You can give up to $17,000 per person in 2023 without triggering gift tax or having to file a gift tax return in most cases.
• You and your spouse can each make $17,000 gifts, and apply your exemptions to the same gifts if needed.
• Some gifts, like payments directly to schools or hospitals, are exempt from gift tax over and above the $17,000 annual limit.
• With smart planning and consistent annual gifts, you can transfer substantial wealth tax-free over time.
• Always consult with your tax and estate planning professionals to optimize your gifting strategy and stay compliant.

By maximizing your annual gift tax exemption as part of a comprehensive estate plan, you can provide meaningful financial support to your loved ones now while reducing your taxable estate over the long term. And that's a gift that keeps on giving.

For more personalized guidance, consider reaching out to a qualified estate planning attorney or tax professional. They can help tailor a gifting strategy to your unique financial situation and goals.