When you give gifts to anyone other than a spouse, gift tax rules may apply. But this rarely results in needing to pay any taxes. Here’s what is required by the rules, and how they might apply to you.

The Yearly Gift Tax Exclusion

For 2023, you can give gifts up to $17,000 per person with absolutely no tax consequences. This means you could give $17,000 each year to each of your children or grandchildren and never pay any tax or be required to file a gift tax return. This annual exclusion amount is occasionally adjusted for inflation.

If you exceed $17,000 in gifts to a single person, you need to file a gift tax return with the IRS for that year.

How the Gift Tax and Estate Tax Work Together

Filing a gift tax return does not necessarily mean that you pay any gift tax. Any gifts over $17,000 simply reduce your lifetime gift and estate tax exemption.

In 2023, this lifetime exemption is $12.92 million for each individual. And it means that if you pass away with assets valued at greater than $12.92 million, you would owe estate taxes on the amount above the exemption.

Let’s take a look at a couple examples:

1. Let’s say you pass away with $13.5 million worth of assets and did not give any gifts that were over the annual exclusion throughout your lifetime. This means you would owe estate taxes on $580,000 – the difference between your total assets and the lifetime exemption.
2. Now let’s say you pass away with $12.5 million of assets, but in the year before you died, you gifted your child $1,017,000. Since this amount exceeds the $17,000 annual exclusion by $1,000,000, your lifetime exemption is reduced by $1,000,000. Your lifetime exemption is now $11.92 million, and you still owe estate taxes on $580,000 at the time of your death.

How the Gift Tax Impacts Young Families

There are a couple scenarios for young families to be aware of when thinking about gift tax rules. 

Any contributions to a custodial/UTMA account or a 529 college savings account are considered gifts to the child who either owns the custodial account or who is the beneficiary of the 529 account. So any contributions over $17,000 will reduce your lifetime exemption, and you need to file a gift tax return.

One exception to this rule is the ability to “superfund” a 529 plan. The IRS allows you to contribute a lump sum of up to 5 times the annual exclusion ($85,000 for 2023) to a 529 plan in a single year. The gift is considered as having been made evenly over 5 years and does not reduce your lifetime exemption. But if you do contribute the full $85,000 allowed, you cannot make any additional gifts to that child until the 5 year period has ended.

The last consideration to be aware of is that tuition paid directly to an educational institution on a child’s behalf is not considered a gift. This applies only to tuition and not room and board, books, or supplies. 

Conclusion

As you can see, for most people the gift tax rules never result in any actual tax being paid. But it is important to be aware of the annual exclusion limits so that you can properly report any gifts that will reduce your lifetime exemption.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.