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Lisa Richmond-Kirby
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What High-Earners Should Know About the Gift Tax

Are you planning on giving money to your family or loved ones this year?

While you may be generous with your money, the IRS isn’t. Because of this, it’s essential to understand the gift tax and its limits.

By having a base knowledge of the gift tax in your back pocket, you’ll be able to make a more strategic and intentional plan for giving while ultimately helping your estate in the long run.

What’s the Gift Tax?

The IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” Some examples could include:

  • Money
  • Stock
  • Real Estate
  • Other Assets

The gift tax is the amount an individual can give to someone without having to report it to the IRS. However, if you take out your magnifying glass to read the fine print, there are exceptions.

The IRS allows you to give a certain amount within a calendar year before reporting it, and it’s $16,000 per individual in 2022. Married couples can maximize their gifts by each giving away the full amount. So, parents could give $32,000 to their child for throwing a wedding, contributing to a downpayment on a house, or anything else.

Should you find yourself in a situation where you’ve exceeded the yearly gift limit, you must file Form 709 along with your annual taxes. If you exceed the limit, your estate may need to settle the tax bill over time! Think of the ”gift tax” as an “IOU” to the IRS—a way to keep track of the gifts you give throughout your lifetime.

Understanding the Lifetime Exclusion

So, how do you know when you’ll owe taxes on your gifts? You’ll have to refer to something called the “lifetime exclusion,” and it’s exactly what it sounds like! Each time you give a gift over the yearly allotted limit, it is deducted from your lifetime exemption total.

The lifetime exemption is currently $12.06 million and doubled for married couples. While this number seems high, the Tax Cuts and Jobs Act sunsets in 2026, bringing the lifetime exemption along with it unless Congress passes other legislation first. If nothing happens, Congress predicts the number will drop to $6.4 million, which could impact many more high-net-worth families.

Both numbers are large on the surface, but depending on your assets, you may be closer to the limit than you realize.

Consider Giving Throughout Your Lifetime

It really can be like The Holiday’s all year round! If you prioritize giving throughout your lifetime, you won’t have to worry as much about estate taxes. This is mainly because you won’t owe the gift tax while alive. As we mentioned, it serves as a form of “IOU” to the IRS.

Every time you gift over the yearly limit, it will eat away at your lifetime exclusion. But, by giving money while you’re alive, you shrink the value of your estate which can potentially help you to avoid substantial estate taxes.

One significant benefit of giving throughout your life (rather than through your estate) is the difference in the tax percentage associated with each category. For example, the top estate tax rate is 40%. If your estate is valued at more than $12.06 million, it will be taxed at a 40% rate, which limits the dollar amount that you can pass on to your heirs.

Let’s take a look at an example. If you give your child $16,000 to start a business, they don’t have to report that gift to the IRS. But, if you left them the same amount of money in an IRA or brokerage account, they’d have to pay taxes on it eventually.

What Gifts Are Free From Tax?

Is your gift going to a charity? Or to cover medical costs or related expenses? There are a few types of “gifts” that are exempt from the gift tax, like:

  • Qualified charitable contributions
    • The IRS doesn’t consider charitable donations to be gifts. High-earners can benefit from a defined charitable giving strategy. We can help you create one that amplifies your giving while remaining tax-friendly.
  • Direct payments to an educational institution.
    • Maybe you want to gift your grandchild their first semester’s tuition. You can pay the school directly and avoid incurring a gift tax.
  • Direct payments to a medical facility.
    • It could be helpful if you want to help aging parents/relatives with medical expenses. Make payment directly, and you don’t have to report it as a gift.
  • Front-loading a 529 plan
    • 529 plans don’t have contribution limits (most have sky-high lifetime contribution limits). Instead, people follow the gift tax rules because if you give more than the yearly allotment for one person, you will have to report it to the IRS.
    • But, this type of plan has a unique “super-funding” option. In addition to sporting a red cape, super funding a 529 plan enables you to put in a lump sum of 5 years’ worth of contributions at once. The idea is to put the “max” amount into the account that the IRS allows at one time ($16k x 5), or $80,000 in 2022.

Build A Strong Estate Plan

Understanding the gift tax enables high earners to be more strategic about their lifetime giving patterns and remain cognizant of the value of their estate.

While the gift tax plays into your present financial strategies, it also applies to your estate plan.

An estate plan is all about setting your loved ones up for success! Aside from identifying beneficiaries, dividing up your assets, and helping to set up those who survive you, an estate plan can spare your family a hefty tax bill.

Having a plan for how you will “gift” throughout your life and estate plan is critical in ensuring that taxes won’t burden you and your loved ones. That’s why working with a team you can trust is essential.

Our team has been serving the dreams and needs of our customers for 150 years. We’ll walk alongside you to ensure you have a financial plan that works best for you and your loved ones. We’re excited at the opportunity to work with you. Please contact us today to reach your financial dreams.

Disclaimer:

First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.

Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust Department, or its employees provides tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.