Do I Have to Pay a Gift Tax? Dispelling Misconceptions: Unraveling Estate and Gift Tax Myths
Navigating the realm of estate and gift tax often comes with a web of misconceptions that can leave Americans uncertain about their obligations. From the belief that everyone is subject to payment, to the assumption that recipients always bear the burden, and the notion that there are strict limits on what can be received – these myths span a wide spectrum. However, the current landscape deviates considerably from these misconceptions, and by shedding light on these misunderstandings, can provide much-needed clarity, potentially offering many a reassuring sigh of relief.
Under current law, an individual has the freedom to “gift” up to $12.92 million during their lifetime, at their death, or through a combination of both. However, any transfer of wealth surpassing this $12.92 million threshold triggers taxation. For instance, if someone gifts $20 million to their child during their lifetime, they will be subject to gift tax on $7.08 million. Additionally, upon their death, the entirety of their assets will be subject to taxation. Conversely, if an individual refrains from making lifetime gifts but passes away owning assets valued at $20 million, they will face estate tax on $7.08 million.
The estate and gift tax function as a unified system, creating a cumulative effect. The IRS keeps a record of gifts made during one’s lifetime, combining their value with the assets held at the time of death to determine what taxes are owed by the estate.
Here’s an example that might help explain things: Imagine someone gives their child a gift of $5 million during their lifetime. This gift is reported on a form called the gift tax return (Form 709), which needs to be filed by April 15 of the following year. Now, the good news is that when they file this form, they won’t have to pay any tax. Why? Well, it’s because the $5 million gift is less than the $12.92 million exemption.
However, let’s consider another scenario. If this person passes away with assets worth $10 million, their estate will need to pay estate tax on $2.08 million of those assets. It might seem a bit confusing, but think of it this way: The gifts you’ve given over time add up. In this case, the $2.08 million is calculated like this:
$12.92 million (the gift threshold) – $5 million (the gift) = $7.92 million (remaining gift threshold)
$10 million (assets when passing away) – $7.92 million (remaining gift threshold) = $2.08 million
What’s interesting is that in this situation, the person only pays estate tax, not gift tax. And here’s an important point: If someone gives away $5 million during their lifetime and passes away with assets worth $5 million, they won’t have to pay either gift or estate tax. That’s because the total of their gifts and assets doesn’t go beyond the $12.92 million threshold.
So, you see, understanding how gifts and assets play a part in taxes can make a big difference. It’s like fitting pieces of a puzzle together to make sure you’re not paying more tax than necessary.
To add a layer of intricacy to the estate and gift tax system, the US Tax Code incorporates an annual exclusion for gifts. As of 2023, this exclusion stands at $17,000 per person giving the gift and per recipient. The beauty of the annual exclusion lies in its nature – gifts equal to or below this amount don’t necessitate reporting to the IRS.
The rationale behind the annual exclusion revolves around distinguishing between substantial gifts and smaller, everyday ones like those exchanged on holidays or birthdays. These minor gifts, not being the primary focus of estate and gift taxation, are exempt from reporting. For instance, if an individual presents a gift of $50,000 to their child, while it may still be subject to reporting, no gift tax needs to be paid. Instead, the gift diminishes the total amount the giver can transfer upon their demise by $33,000 (calculated as $50,000 – $17,000). Consequently, an individual gifting $50,000 to their child could eventually leave assets totaling up to $12,887,000 upon their passing, without incurring any estate or gift tax obligations.
The examples provided refer to single individuals. The amount increases with married couples who consent to making gifts (called gift splitting) and who grant permission to allow a deceased spouse to use their unused exemption.
Why does this matter? A common misunderstanding exists that you can only give $17,000 to your child before needing to be concerned about a gift tax. However, as explained earlier, that’s not entirely true. Moreover, only a tiny portion of Americans (less than 1%) possess assets worth $12.92 million or higher. This means very few people should actually worry about facing a gift tax issue.
If you’re someone considering giving a gift to a friend or family member, such as helping with college expenses, funding a wedding, or contributing to a home down payment, there’s only a need to reconsider if your total assets go over $12.92 million. For most Americans, making such gifts shouldn’t raise any concerns under the current law. There’s a minor catch, though – the current law anticipates a decrease in the exemption amount starting in January 2026. Even if this decrease occurs, experts predict the exemption will still be higher than $7 million, which is more than the wealth of many Americans.
Should you have inquiries about estate and gift taxes, seeking advice from an expert is advisable.
Letha Sgritta McDowell
757-399-7506 | 252-722-2890
Letha Sgritta McDowell is a Shareholder of Hook Law practicing in the areas of estate planning, elder law, special needs planning, estate and trust administration, asset protection planning, long-term care planning, personal injury settlement consulting, guardianships & conservatorships, and tax law. Ms. McDowell’s clients range from high-net-worth individuals with over $75 million in net worth to families with limited assets.
Ms. McDowell is a past President of the National Academy of Elder Law Attorneys and was named as a Fellow of the prestigious American College of Trusts and Estates Council (“ACTEC”) in 2020. She is certified as an elder law attorney by the National Elder Law Foundation (“CELA”) and Board Certified as a specialist in Elder Law by the North Carolina State Bar Board of Legal Specialization. Furthermore, McDowell is accredited to prepare and prosecute claims with the Department of Veterans Affairs.
Ms. McDowell is currently the chair of NAELA’s strategic planning committee, a member of the Board of Directors for the North Carolina Chapter of NAELA, and a member of the Board of Directors for the Purdue Center for Cancer Research. She is the former Chair of the North Carolina State Bar’s Elder Law Specialization Committee and is the former Editor-in-Chief of “Gray Matters”, the newsletter for the Elder Law Section of the North Carolina Bar Association. She is a consultant for InterActive Legal and has worked on several law and technology initiatives including IBM’s Watson project. Along with her experience practicing as an attorney, she has dedicated much of her time writing for national publications including, but not limited to: Wolters Kluwer, Wealthmanagement.com, the NAELA Journal, Trust & Estates Magazine and many more.
- Elder Law
- Estate & Trust Administration
- Estate Planning
- Asset Protection Planning
- Long-Term Care Planning
- Special Needs Planning