Gift and estate taxes are federal taxes imposed on the transfer of wealth from one individual to another, either during life or at death, based on the unified transfer tax. The unified or uniform transfer tax combines the total of both gift and estate taxes, as well as the generation-skipping transfer (GST) tax.
What are the different types of taxable gifts?
Gifts can take many forms, including transfers of cash, property, sales of property at a bargain price to a family member, loans to family members on which a fair rate of interest is not charged, and irrevocable trusts established for others in which the income and/or corpus beneficiary is someone other than the taxpayer.
It is important to note that not all transfers of wealth are considered gifts for tax purposes. For example, taxable gifts do not include transfers to spouses, support for minor children, transfers to qualified charitable organizations, political contributions, and payment of medical expenses or tuition of another. Note that for payment of medical expenses or tuition to not qualify as a gift, they must be made directly to the health care organization or education provider. Additionally, there is an annual inflation-adjusted gift exclusion of $16,000 (in 2022) per gift recipient.
When it comes to gift taxes, there are three types of transfers that may take place during a person’s lifetime (inter vivos):
- Gift of a present interest – An immediate transfer of wealth that can be accessed by the recipient right away. A gift of a present interest normally must be reported in years in which the taxpayer transfers more than $16,000 in wealth to a single individual, or $32,000 for those married filing joint with the gift-splitting election.
- A present interest exists if there is:
- An annuity starting presently.
- Immediate outright ownership of the property gifted.
- A guaranteed right to immediately receive the income stream generated by a property, such as dividends, rents, etc.
Note that a delayed or future right to property does not qualify. If depositing cash into a joint bank account with an intended beneficiary, there is only a gift transfer when the beneficiary withdraws funds from that account for their own benefit.
- Gift of a future interest – An irrevocable transfer of the right to access wealth in the future. A gift of a future interest must be reported at the present value of the future interest.
- This includes any gift in which the amount is not immediately available to the beneficiary.
- Gifts of a future interest do not qualify for the $16,000 annual exclusion.
- Uncompleted gift (no interest) – A revocable transfer of the right to access wealth in the future. An uncompleted gift is not reported, and the wealth is still considered a part of the taxpayer’s estate if they retain their right to revoke the transfer, such as in a revocable trust.
If a trust’s income goes immediately to one beneficiary each year, and the principal (called “corpus”) will go to another when the trust terminates, then the grantor of the trust is making a gift of a present interest to the income beneficiary every year and a gift of a future interest to the remainder beneficiary, provided the trust is irrevocable. In this way the interests in the same trust can effectively be split between present and future.
What are the rules and exclusions for Gift and Estate Taxes?
Gifts made during a person’s lifetime are reported on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. The estate tax return (Form 706) then combines all reported gifts and the value of the estate at death to determine if any additional taxes are due.
Form 709 must be filed with the IRS by April 15th of the following year for any gifts made in excess of the annual exclusion of $16,000. The return is used to report the total amount of taxable gifts made during the calendar year and any gift tax due.
On the gift tax return, the donor must report the value of the gift, the identity of the recipient, the date of the gift, and any applicable deductions or exclusions (as previously stated, these include support for minors, the marital deduction, and directly paid education/medical bills in addition to the annual exclusion). The donor may also elect to split gifts with their spouse, allowing each spouse to utilize their annual exclusion amount and lifetime exclusion amount (discussed below), treating each as having given half of the amount of any gift given by either spouse.
If the donor made any gifts of a future interest during the year, the gift tax return must also include a statement that describes the nature of the interest and its value. Additionally, if the donor made any generation-skipping transfers during the year (discussed below), they must report those transfers on the gift tax return.
What is the lifetime gift tax exemption?
Each individual taxpayer is permitted to make taxable gifts up to their lifetime limit before owing any gift tax. The lifetime exemption amount is $12,060,000 for 2022. This means that an individual can gift up to $12,060,000 during their lifetime without owing any gift tax. This lifetime exemption amount is adjusted annually for inflation.
Since gift taxes are applied on an individual basis, a married couple can each use the annual and lifetime exclusions mentioned. As previously stated, they can also agree to split large gifts made by one of them and treat each as having given half of the amount.
Portability between spouses permits a surviving spouse to apply the decedent’s unused exemption amount to the surviving spouse’s own transfers. This means that if the decedent spouse did not use their entire lifetime exemption, the unused portion can be transferred to the surviving spouse, allowing them to give away more during their lifetime without owing any gift tax.
What is the Generation-Skipping Transfer Tax (GST)?
In addition to the gift tax, there is another component to the unified transfer tax known as the generation-skipping transfer (GST) tax. This tax is imposed when the donor transfers substantial property to beneficiaries who are at least two generations below the donor. The GST tax only applies when amounts exceeding the lifetime exemption ($12,060,000 for 2022) are transferred. This exemption is separate from the lifetime exemption on gift and estate taxes, so it is therefore possible that any tax resulting from transfers exceeding this amount could be owed in addition to those taxes.
The purpose of the GST tax is to prevent taxpayers from avoiding the transfer taxes on one generation by giving, for example, to their grandchildren instead of their children. The amount of the GST tax will usually be a similar amount to the additional transfer taxes that would have been paid if the taxpayer had transferred the property to their children first, who then transferred the property to the grandchildren.
It’s important to note that the GST tax does not apply to transfers to a grandchild if the taxpayer’s child who is the parent of the grandchild is already deceased, as this would make the grandchild the first generation below the donor.
Gift and estate taxes are complex theories that can be difficult to comprehend but are important to consider along with one’s personal and/or business tax planning. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal, or accounting advice. If you have any questions about gift or estate tax planning strategies, please do not hesitate to contact us at Lear & Pannepacker.