There are new rules for how much you can donate to others each year without tax consequences and how much of your estate you can leave to heirs free of the 40% estate tax.
It's that time of year when thoughts turn to tax returns how much you can donate to others without using your estate tax exemption.
How much you can donate to your heirs or others without tax consequences.
In 2021 you could donate $15,000 to as many different people as you want without having to report the gift on federal gift tax return IRS form 709. That number of $15,000 is subject to being increased each year due to an inflation adjustment. But it can only go up in increments of $1,000 and it doesn't go up every year. The last time the annual exclusion amount changed was in 2018. So from 2018 through 2021 you were limited to a $15,000 donation before you had to report the gift on a gift tax return.
In 2022 the annual exclusion amount was increased from $15,000 to $16,000. What does this mean? Starting on January 1, 2022, you can donate $16,000 to as many people as you want without filing a federal gift tax return. If you are married you and your spouse can each donate $16,000 or between you and your spouse you can donate $32,000 without having to file a gift tax return. If you do transfer or donate more than $16,000 to any one person in 2022 you will be required to file a federal gift tax return to report that gift was made but neither you or the person you made the gift to will be required to pay tax. By making a gift in 2022 in excess of $16,000 you are merely using some of your estate exemption. Or, you can use your gift tax exemption when you pass away.
2023 Gift Exclusion Amount and Life Time Estate Tax
The amount you can give away without filing a gift tax return in 2023 is $17,000 per recipient. You only have to file a federal gift tax return also known as form 709 if you make a gift to someone that exceeds $17,000. Married couples can give $34,000 per year per recipient in 2023 without gift or estate tax consequences.
Donated assets are not subject to the 40% estate tax when the donors pass away. If you make gifts in excess of the $17,000 annual gift tax exclusion during 2023 you will use a portion of the lifetime gift and estate tax exemption.
Most people don't have an estate that will require federal estate tax to be due when they pass away. So when someone says "we want you to help us avoid this death tax or estate tax; we have worked hard to accumulate an estate worth about $1.2M and we want to avoid this tax".
BUT: So long as when you pass away you have less than $12.92 MILLION dollars, or $34 Million dollars if you are married, federal estate tax is not something you have to worry about. So your estate will be passed to your survivors intact.
These two exclusions: the gift tax exclusion of $17,000 and the life time estate tax exemption of $12.92 Million (double that for married people) are linked. When someone makes a gift that exceeds $17,000 in 2023 it will reduce the amount that that person can leave at their death estate tax free.
Most people say that the $12.92 Million life time tax exclusion will not apply to them. That is true. And, this amount will continue to creep up in 2024 and 2025 based on inflation adjustments. In 2026 the exclusion amount is scheduled to be cut in half for persons that pass away on or after January 1, 2026.
There are a few reactions on the $12M gift tax exclusion or $34 million for married people:
- that would be a nice problem to have; we don't have that problem
- we will contact you when we win the lottery
- the rich always find a way to get around paying tax
The questions are:
- are you sure no one pays tax over $17,000? Yes--here is no income tax on a gift regardless of the value of the gift;
- if I sell to my son my house for $100,000 does that get around the gift tax? No--if you sell a house worth $400,000 to your son for $100,000 you have just made a gift of $300,000 (the fair market value is a gift);
- since I have a beneficiary on an account is it in my estate and subject to estate tax when I die? Yes--the IRA's that you own, the life insurance that you own, the annuities that you own, all those assets that you own even if you have a beneficiary designated who will immediately get those funds upon your passing away upon producing a death certificate those funds are still part of your estate subject to the estate tax;
- why are you even telling us this if it doesn't apply to 99% of us? Even though you have an estate worth only say $1M I need to tell you about the life time tax exclusion of $12M in case we need to maneuver assets to get around it;
- is the 40% tax on the part just over the threshold or does the tax apply to all of the estate once you get to $12 million? It only applies to those assets that exceed $12 million dollars;
- how is it that the government taxes already taxed money--isn't that double taxation? Well, it's legal because Congress makes the rules and Congress says it is legal;
- doesn't the recipient of the gift have to pay income tax? No. If you receive the gift, whether it is less than or more than the $17,000 exclusion for 2023 the recipient of the gift does not pay income tax on the gift nor does the donor get to deduct that in any way for purposes of their income tax reporting;
- what if you use your $12M exemption during your lifetime and then you die when the exemption is lower? Based on recently issued regulations, you will get the exemption that applied the larger that applied when you either made that gift or the exemption at the time of your death--so the IRS will not claw back that big gift you made when the life time gift exemption is reduced;
- does the gift tax exemption only apply if you gift to children? No. You can give $17,000 to your friends or whoever you want to so not just to descendants;
- what if the donor makes a taxable gift (more than $17,000) and doesn't file a gift tax return? The penalty for failing to report a gift don't apply unless gift tax is due, and gift tax is due only if you have used up your entire $12 million gift and estate tax exemption, and then you make further gifts that require gift tax to be paid. So there is often no financial penalty for failing to file an IRS form 709 when it is required that you report a gift;
- does it matter if the gift is cash a shoe box of cash or under the table? No. The gift and estate tax system is a voluntary reporting system to if you give a bunch of cash to someone, and it exceeds the gift tax exclusion, you are required to file a IRS form 709;
- what if I buy a car and then I just transfer title to my daughter? It is a gift whether you write the person a check, give them cash or transfer the title to the car to their name or buy them a car or piece of land--all are gifts subject to the gift tax exclusion;
- is there a birthday or Christmas gift exception? No. There is no exception for birthday or Christmas gifts;
- does this apply to gifts in trust? Many people like the idea of getting assets out of their estate to avoid estate tax but they don't like the idea of just writing a check to their child or grandchild for $17,000 or $34,000 because that child may mot do the right thing with that money. So many people make those gifts into a special kind of trust. You can make the gift outright or make the gift into a trust if you want to maintain more control over the gift. The same rules apply whether you gift outright or into a trust.
- Does the gift reduce your taxable income? no. No correlation between gift tax and income tax.
Bottom line: The life time tax exclusion does not apply to most people and generally only applies to people with estates over $12M dollars (or double that if you are married).
Note: The income tax and the gift tax are NOT related.
Keep in mind there are many non-estate tax related issues that we do address like: making sure the right assets go to the right people; making sure the right people are appointed to handle your estate in the future; and minimizing or avoiding probate or other government interference play a role in protecting your estate for you and your loved ones.
Myths about the gift tax exclusion:
- If you make a gift larger than $17,000, no one owes any tax. Some people inaccurately believe that if a gift larger than $17,000 is made then someone, either the person who made the gift, the donor, or the person receiving the gift, the donee, must pay income tax. It is just not true. The only time someone owes tax on a gift is when the gift is so large they use both the $17,000 annual exclusion amount and the $12 million annual exclusion amount. Those gifts are rare.
- There is no limit as to how many people you can give $16,000 to in 2022 or ($17,000 in 2023). If you are married and you have 5 children and 25 children you could give between you and your spouse $34,000 to 30 people.
- You are not limited to giving only to family. You can make the gift to anyone, whether they are related to you or not.
How much of your estate can you leave to your heirs without the 40% estate tax.
For people who pass away in 2022, the basic exclusion amount is increased from the 2021 exemption of $11.7 million to the new 2022 exclusion amount of $12 million sixty thousand dollars. It gets even bigger if you are married. If you are married, both you and your spouse have an exemption of $12 million sixty thousand dollars. So between both of you, you could leave $34 million dollars to your heirs free of the 40% federal estate tax.
If you would like to talk over your estate plan, or need help with a probate, please call me at 307.200.1914.